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Abstract
Using a unique empirical setting, family rms in the S&P 500, Ali et al. [Ali, A., Chen, T.-Y.,
Radhakrishnan, S., 2007. Corporate disclosures by family rms. Journal of Accounting and
Economics, doi:10.1016/j.jacceco.2007.01.006] contribute to a growing body of research on the
relation between corporate governance and corporate disclosure quality. Using an indicator variable
for sub-sample membership as an instrument for differing agency costs, the authors interpret their
ndings as consistent with family rms facing lower overall agency costs and providing higher quality
corporate disclosures. However, their empirical ndings are open to alternative interpretations and in
totality present relatively weak, indirect evidence of a relation between corporate governance and the
quality of corporate disclosure.
r 2007 Elsevier B.V. All rights reserved.
Keywords: US family rms; Corporate disclosures; Earnings quality; Corporate governance; Management
forecasts; Analyst forecasts; Bid-ask spread
1. Introduction
Several years before the fall of Enron, regulators and other capital market participants
made known their growing concerns about questionable disclosure practices and the
quality of earnings reported by US Corporates (see Levitt, 1998; Brown, 1999; Parfet,
2000). Since Enron, corporate America has come under even greater scrutiny and increased
regulation. E.g., Sarbanes Oxley is, at least in part, intended to enhance the role of
corporate governance in safe guarding the quality of reported earnings and overall
corporate disclosure.
0165-4101/$ - see front matter r 2007 Elsevier B.V. All rights reserved.
doi:10.1016/j.jacceco.2007.01.004
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With growing interest in the topic, recently researchers have attempted to examine
directly whether and how corporate governance affects earnings quality and overall
corporate disclosure quality. Specically, several research teams use the international
setting to compare internationally the quality of corporate governance and disclosure (see
e.g. Ball et al., 2003; Bushman et al., 2004; Khanna et al., 2004). While demonstrating that
higher quality governance is associated with higher quality disclosure and greater
transparency, the international research does not provide direct evidence on how specic
differences in corporate governance practices across US rms affects the quality of their
reported earnings and disclosure practices. Ali, Chen and Radhakrishnan (2007, hereafter
ACR) attempt to address this very interesting question: Does cross-sectional variation in
US corporate governance practices help to explain cross-sectional variation in managerial
choices of corporate disclosure policies?
Using Business Weeks split of the S&P 500 into family and non-family rms, the
ACR paper examines whether family rms corporate disclosure policies differ from
those of non-family rms. They argue that family rms face less severe agency problems
arising from the separation of ownership and control, but more severe agency
problems arising between controlling and non-controlling shareholders. The authors
use an indicator variable for sub-sample membership as an instrument for differing
agency costs and examine the relation between agency costs and corporate
disclosure choice. The authors interpret the evidence presented as largely consistent with
family rms facing lower overall agency costs and providing higher quality corporate
disclosures.
The paper is a reasonable rst attempt at demonstrating an association between agency
costs and corporate disclosure within the US setting, in as much as it uses an interesting
empirical settingfamily rms in the S&P 500. However, the decision to examine family
rms also raises concerns that key results are spurious. As I discuss below, if family rms
only retain ownership and control of successful rms and if, as documented by Miller
(2002), disclosure quality is positively related to rm performance, then the relation
between family rms and disclosure choices may be spurious. Other empirical ndings
presented in the paper are also open to alternative interpretations. Thus, in totality the
paper presents relatively weak and indirect evidence of a relation between corporate
governance and the quality of corporate disclosure.
Section 2 outlines the research questions examined by ACR. Section 3 discusses Business
Weeks denition of family rms, sample selection bias, and descriptive information.
Section 4 comments on the tests reported in the paper and the interpretation of results.
Section 5 summaries the contribution of the paper and provides suggestions for future
research.
2. Research questions
The authors focus on regressions aimed at measuring the relative level of the variables
of interest across family and non-family rms. The research questions addressed in this
paper are:
1. Are discretionary accruals smaller in absolute magnitude for family versus non-family
rms?
2. Are signed discretionary accruals smaller for family versus non-family rms?
3. Do the components of earnings do a better job predicting cash ows for family versus
non-family rms?
4. Do family rms have more persistent earnings than non-family rms?
5. Do family rms have larger earnings response coefcients than non-family rms?
6. Are managers of family rms more likely to provide an earnings warning for the same
level of negative earnings news?
7. Do family rms provide less voluntary disclosure about their corporate governance
than non-family rms?
Once the authors present results interpreted as indicating that family rms have better
disclosure practices than non-family rms, they go on to assess whether these rms
experience the usual benets of better quality disclosure (Botosan, 1997; Healy et al., 1999;
Welker, 1995). Once again the authors employ regression analyses to assess whether the
level of the variables of interest differ across family and non-family rms. The specic
research questions addressed to assess whether family rms enjoy the benets of better
quality disclosure are: Compared to non-family rms,
While the research questions addressed in the paper are of interest, there are several
empirical opportunities that are overlooked by the authors: (1) Since earnings management
via manipulation of real activities is often value destroying and since founding families
often hold large ownership stakes in their rms, one would expect family rms not to
change the real business activities of the rm to meet an earning benchmark.1 Neither
ACR nor Wang (2006), a contemporaneous paper that also documents earnings quality for
family rms in the S&P 500, examine whether family rms engage in less manipulation of
real activities to manage earnings than non-family rms. (2) Since founding families are
long-term investors with potentially under-diversied portfolios, one would expect family
rms voluntary disclosures in the quarterly earnings process to differ from non-family
rms. (3) Given differences in corporate governance and disclosure practices of family
versus non-family rms documented in both ACR and Wang (2006), it would be
interesting to know whether institutions invest more or less heavily in family rms.
Univariate analyses presented in both papers suggest that institutions invest less heavily in
family rms. Multivariate analysis is needed to draw useful inferences.
1
Roychowdhury (2006) provides a methodology for measuring manipulation of real business activities.
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Inferences drawn from the ndings documented in this paper depend critically on the
classication scheme for family and non-family rms. ACR splits the S&P 500 into family
and non-family rms based on Business Weeks classication provided in a special report
on family rms in its November 10, 2003 issue.2 The purpose of the Business Week special
report is to compare the performance of family and non-family rms over the time period
19922002. Business Weeks denition of a family rm, any company where founders or
descendants continue to hold positions in top management, on the board, or among the
companys largest stockholders, results in 177 of the rms in the July 2003 S&P 500 stock
index being classied as family rms.
Based on Business Weeks denition, the sub-sample of family rms in the S&P 500
includes a wide range of rms from Microsoft, known for its conservative accounting
choices, to Campbell Soup Co., Cendant, and Computer Associates, all known for their
accounting scandals. A supplement to the Business Week special report, Dening
Family, indicates that where founders owned stock but were not involved in day-to-day
operations, Business Week used its judgment, taking into account the size of the founders
ownership stake. The supplement also indicates that Business Week included rms without
founders or descendents present, if either had been active for the bulk of its sample period.
The decision to rely on Business Week for the classication of rms leaves the ACR
paper open to several criticisms. First, it is unclear that the family rm distinction dened
by Business Week is the most powerful classication for addressing ACRs research
questions.3 Second, even if one agrees with the criteria Business Week used to dene a
family rm, a quick review of the Business Week list of family rms and the accompanying
details indicating why each rm is classied as a family rm, raises concerns about Business
Week as an objective, scientic research entity. For instance, Business Week classied
Chubb Corporation (ticker symbol CB) as a family rm because the founders heir, Percy
Chubb III, is a non-voting director emeritus on the insurance companys board of
directors. The Chubb family retains no signicant stock ownership in the company. As
another example, Business Week classied Cummins Inc. (ticker symbol CMI) as a family
rm because director William Miller is a distant relative of W.G. Irwin, the banker who
supplied the start-up capital in 1919. The Irwin family retains no signicant stock
ownership in the company. Neither of these rms appear to have founding families
retaining signicant control over the corporation either from a managerial decision
making or from a stock ownership perspective. There are other questionable classications
readers may review on the Business Week website noted in footnote two of this discussion.
A third criticism arises from the decision to focus on the family rm distinction per se as
a way to identify differing agency costs. If families tend to exit or lose control of poor
performing businesses, then a sample selection bias existsfamily rms will systematically
2
See the following website for details on each of the 177 rms from the July 2003 S&P 500 stock index that are
dened by Business Week (2003) as a family rm: http://bwnt.businessweek.com/family_companies/2003/
index.asp?sortCol=rank&sortOrder=ASC&pageNum=4&resultNum=50§or=
3
See Wang (2006) for an alternative classication of the S&P 500 into founding family rms and non-founding
family rms. Wang also employs a continuous variable, founding family ownership.
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outperform non-family rms. The authors decision to focus on the S&P 500 has the
potential to mitigate this performance bias, since all rms in the S&P 500 perform well
historically or they would not be included in the S&P 500. However, prior research
demonstrates that within the S&P 500 family rms are more protable than non-family
rms (Anderson and Reeb, 2003). Thus, the performance bias prevails in the sample of
S&P 500 rms and it is important for interpreting ACRs results, since Miller (2002)
documents that rm performance is positively associated with voluntary corporate
disclosure. As the authors note (on page 18 of the text), the key ndings in the paper may
reect spurious correlation. Specically, better rm performance is associated with the
family rm distinction; better rm performance is also associated with higher quality
disclosure; thus, while the family rm indicator variable is positively associated with higher
quality disclosure, it is potentially spurious correlation.
Finally, the focus on the S&P 500 limits generalization of the ndings. In particular,
ndings presented in this paper do not rule out managers of family rms being more likely
to resort to manipulating reported results when faced with several years of poor
performance. In fact, when faced with such extreme circumstances, CEOs that are
founders are documented to be more likely to manipulate reported results than non-
founder CEOs (see Dechow et al., 1996). Anecdotal evidence also suggests that family
rms resort to earnings management when facing downturns: Adelphia, Campbell Soup,
Cendent, Computer Associates, and Rite Aid Corp., just to name a few famous cases.
The authors attempt to provide external validation of the Business Week classication
by providing descriptive statistics on salient rm characteristics in Table 2. Panel B is the
most revealing with its comparison of the family and non-family rms corporate
governance variables. Family rms have much larger share ownership by ofcers and
directors, consistent with the authors contention that these rms face less severe agency
problems arising from the separation of ownership and control. Consistent with family
rms facing higher agency costs arising between controlling and non-controlling
stockholders, the percentage of independent directors is lower for family rms and the
percentage of rms with an outside blockholder is also lower for family rms.
Finally, Table 2 Panel B indicates that the frequency with which the CEO serves as the
Chairman of the Boards is lower for family rms. This statistic is difcult to interpret,
however. One interpretation is that family rms have better corporate governance with
reduced opportunities for managerial entrenchment as power is shared between two
individuals who provide a check and balance on one another. However, in this current
context, what really matters is the identities of these two individuals. If both are members
of the founding family, then perhaps this statistic suggests greater opportunity for
entrenchment of the founding family and higher agency costs arising between controlling
and non-controlling shareholders. The authors do not examine the identities of the CEO
and Chairman as a way to identify entrenchment of the founding family.
4. Empirical tests
The authors compare several aspects of corporate disclosure across family and non-
family rms: Measures of earnings quality, voluntary disclosure of bad news through
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The authors examination of earnings quality is vefold. They examine signed and
unsigned discretionary accruals, predictability of cash ows, earnings persistence, and
earnings response coefcients. The tests are generally well done, often following closely the
methods developed in prior research. Evidence is presented that is consistent with family
rms having more negative discretionary accruals, earnings components that are better
able to predict cash ows, and higher earnings response coefcients. My discussion focuses
on the inferences that can be drawn from tests with signicant ndings.
accelerate the recognition of income or decreasing net assets to delay the recognition of
income. Research designs that fail to specify income-increasing or income-decreasing
incentives in each reporting period often lead to invalid inferences. For instance, in the
ACR paper, the more negative discretionary accruals for the family rms is just as likely to
be indicative of more rather than less earnings management, when one considers family
rms incentives to report lower earnings, such as their incentives to minimize taxes or
reduce political costs (e.g., Microsoft).
5
To see this, note the discussion in Barth et al. (2001) on page 34 that e.g., the coefcient on ,INV reects the
payment deferred to next period of the current period change in inventory. If a particular rm is able to defer
more of its payments to future periods for the same level of increases in inventory (e.g., Wal-Mart with its power
over its suppliers), then the estimated industry-specic coefcient will be biased when applied to the particular
rm and the estimated residual will be large for this rm, regardless of how well this rms earnings components
predict its future cash ows.
6
See Hribar and Nichols (2006) for a useful discussion of this issue in the context of earnings management tests
that use unsigned discretionary accruals.
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Next, the authors examine whether managers of family rms, in comparison to managers
of non-family rms, are more likely to issue earnings forecasts for a given magnitude of bad
news (Table 7). At rst glance, the tests appear to follow closely Kasznik and Lev (1995).
However, as I discuss below, a close look reveals that the tests differ in important ways.
First, in contrast to prior work, the development of ACRs hypotheses regarding the
association between the likelihood of management earnings forecasts and the magnitude of
the negative earnings news (Hypotheses 2a and 2b) implicitly assumes that management
can withhold bad news indenitely. Otherwise, controlling shareholders would merely
delay rather than escape scrutiny of their private rent seeking and entrenchment activities.
Prior empirical work assumes that managers who do not warn are able to withhold bad
news only temporarily, that is until the annual earnings announcement (e.g., Skinner, 1994;
Kasznik and Lev, 1995). Under this assumption, the primary motivation for managers to
provide earnings warnings is to lower expected litigation costs (Skinner, 1994). Interpreting
ACRs ndings when it is assumed that bad news is revealed at the annual earnings
announcement, family rms are more likely to warn for a given magnitude of bad news
simply because the families themselves bear more of the litigation costs of not warning
given their signicant ownership stakes in the rms. In this light, family rms decisions to
warn are not necessarily indicative of less opportunistic behavior or lower agency costs.
Also in contrast to Kasznik and Lev (1995), ACR does not constrain the horizon of the
management forecasts.7 The reason this constraint is important, examining forecasts made
well in advance of the earnings announcement increases the chances that the forecast was
not intended to warn investors about the upcoming earnings surprise. In fact, if through its
forecast management moved investors expectations away from actual earnings, then the
forecast assists in creating the earnings surprise. This is a concern for the ACR paper, since
the authors did not document nor control for the sign of the news in the management
earnings forecast. Thus, it is unclear whether the management forecasts included in their
analyses were actually intended to warn investors of the upcoming earnings surprise.
To examine whether family rms benet from the higher quality earnings and greater
likelihood of an earnings warnings, next the authors examine whether family rms have
7
Kasznik and Lev (1995) examine only management forecasts made within 60 days of the annual earnings
announcement. Since Kasznik and Lev hand collected their data, I presume that they checked to ensure that the
sign of the news in the management earnings forecast matched the sign of the news at the earnings announcement
date, even though I could not nd a mention of this constraint in the text of the paper.
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The authors conduct tests on sub-samples of the family rms to gain additional
condence that differences in the severity of agency problems across family and non-family
rms drives [their] results. Specically, they classify family rms along two lines: Whether
the rm has dual class shares and whether the CEO is the founder, a descendent of the
founder, or hired. Firms with founder CEOs and no dual class shares are expected to have
less severe agency problems and thus are more likely to exhibit better disclosure practices.
The authors interpret their ndings (in Table 10) as supportive.
Confounding these tests is the fact that the sub-samples of family rms are very unequal
in size. Specically there are only 30 rms with descendent CEOs and only 19 rms with
dual class shares. Thus, the lack of signicant coefcients for these dummy variables may
well reect a lack of power, leaving the added condence in the papers primary ndings
gained from these tests marginal at best.
On the other hand, it would have been interesting to know whether family rms with
family members in executive positions have lower quality disclosures. Sixty-three percent
of the family rms have family members in executive positions, indicating that a split of the
sample on this variable of interest would have provided more even sub-samples and
perhaps more powerful tests. Also, it would have been interesting to know whether family
rms disclosing information about signicant related party transactions (27% of the family
rm sample, reported in Table 8 Panel A) have lower quality disclosures.
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The two agency issues examined in concert in this paper have been examined
individually in prior research. Wareld et al. (1995) examine directly the association
between managerial ownership and earnings informativeness and earnings management.
They nd that managerial ownership is positively associated with earnings informativeness
and negatively associated with the magnitude of discretionary accruals. Francis et al.
(2005) examine directly the informativeness of earnings when cash-ow rights are
separated from voting rights via dual class shares. They nd that earnings are generally less
informative for dual class rms.
This raises the question: How does an examination of family rms contribute to the
existing literature? By the authors own admission, family rms face less severe agency
problems arising from the separation of ownership and control and greater agency
problems between controlling and non-controlling shareholders. Thus, their sample is a
mixed bag of unresolved agency problems, making it more difcult to draw useful
inferences from their ndings.
Nevertheless, family rms offer an opportunity to examine a unique class of
shareholders that hold poorly diversied portfolios, are long-term investors (multiple
generations) and control senior management positions (Anderson and Reeb, 2003,
p. 1304). Beyond existing work on founding-family rms, which examines difference in
performance, capital structure, real investment decisions (rm diversication and capital
spending) and corporate disclosure, additional attributes worthy of examination in the
context of founding-family rms include differences in investor base (e.g., level of
institutional investment) and earnings management through real activities manipulation
(Roychowdhury, 2006).
Additionally, understanding the role of corporate governance mechanisms in limiting
the expropriation of rm wealth by founding families deserves further research. For
example, Anderson and Reeb (2004) demonstrate that founding-family rm performance
depends on board composition. It is likely that risk-aversion behavior in family rms as
well as the level of institutional investment and earnings management via real activities
manipulation also vary with the existence of corporate governance mechanisms intended
to limit the expropriation of rm wealth by founding families.
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