Kiatniyom Kuntisook

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Kiatniyom KuntisookKriengkrai Boonlert-U-Thai

Chulalongkorn Business SchoolBangkok, THAILAND

EMAIL: Kiatniyom_K@hotmail.com

Outline1. Purpose and Motivation of the Study2. Research questions and Findings3. Prior Studies4. Theory & Hypotheses Development4. Theory & Hypotheses Development5. Research design6. Results7. Conclusion and implications

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1. Purpose:

CS Founding Family

Family

1: Replication2: The effect of CS

Characteristics

CS

3

MS

Family

MS

Financial Reporting Conservatism (Cons)

Financial Reporting Conservatism (Cons)

on

1. Purpose:

Founding Family

Family

3: The effect of CS Characteristics

CEO_Founder

CEO_Descendent

CEO_Professional

Management

4

Family

MS

Financial Reporting Conservatism (Cons)

on

CEO_Professional

CEO_Founder

CEO_Descendent

CEO_Professional

1. Motivation: Agency Problem

Agency Principal

Controlling Shareholders

(CS)Agency

ProblemMinority Agent

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Western Asia

Ref: Fan & Wong (2002)

Why Thailand?Controlling shareholder

Characteristics(CS)

95.5%

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Founding Family Firms

(FF)

60.5%

Family Firms (FAM)

35%

Example – True Corporation Public Co., Ltd.

Founder:

Mobile telecommunications

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Founder: Mr. Dhanin Chearavanont

CEO: DescendantMr. Suphachai Chearavanont

Example – Bumrungrad Hospital Public Co., Ltd.

Multi-specialty Hospital

Original Founder: Group of Local Doctor

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New Founder: Bangkok Bank Group

CEO: ProfessionalMr. Curtis Schroeder

Asian form of Agency Problem

• Minorities

• Controlling

-

Entrenchment Effect • Minorities

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+

Alignment Effect

• Controlling Shareholders

New Theories

� Alignment Effect:� Inside directors help the board make

better judgments due to their inside knowledge of the business operations.knowledge of the business operations.

� Entrenchment Effect:� Inside directors may choose projects

unfavorable to shareholders .

Accounting Conservatism

• The accountant’s tendency to require a higher degree of verification when recognizing good news in earnings than for recognizing bad news (Basu, 1997)

Definition

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for recognizing bad news (Basu, 1997)

• Higher Cons = Higher Earnings Quality

• Higher Cons = Less Earnings Management

Implications

Basu (1997)� Basu (1997):

� Cons => anticipate no profits but anticipate all losses.

� As a result => Earnings reflects bad news more quickly then good news.quickly then good news.

� Examples: � Lower of Cost or Market Accounting for Inventories.� Impairment of assets in fixed assets and investments.

Thus, conservatisms result in a greater probability of timely accounting recognition of bad news than good news.

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Thus, the study explores the relationship between:

CS

FF

FAM

Accounting Conservatism

CS FAM

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2: Research questions� Is there a relationship between accounting

conservatism and controlling shareholder characteristics ?� Q1: Is there a relationship between accounting � Q1: Is there a relationship between accounting

conservatism and CS firms ?� Q2: Is there a relationship between accounting

conservatism and FF firms ?� Q3: Is there a relationship between accounting

conservatism and FAM firms ?

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DefinitionsFF � Founding family firms are established by a founder (who

takes responsibility for the firm’s early growth and development).� At least 10% of the firm’s equity is owned by the founder or founding family members by blood or marriage.

FAM � Family firms are firms owned by a family who do not take responsibility for the firm’s early growth and development.responsibility for the firm’s early growth and development.� Firms in this category refer to non-founding family firmsthat have at least 10% of the firm’s equity is owned by members of the new family by blood or marriage.

CS Combined FF and FAM definitions.

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2: FindingsFounding family (“ FF”) firms :�Earnings reports become more timely in

recognizing bad news.�The above results hold for all FF firms run �The above results hold for all FF firms run

by CEO who is:�A Founder,�A Descendent, or �A Professional .

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2: Findings (con’t)Family (“ FAM”) firms :�Earnings reports become more timely in

recognizing bad news.�The above results hold for FAM firms run �The above results hold for FAM firms run

by CEO who is:�A Founder, or �A Professional

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3: Prior Studies Ownership & Firm Performance

�Family firms have higher firm value and performance than non-family firms (Jensen and Meckling 1976; Anderson and Reeb 2003; and Meckling 1976; Anderson and Reeb 2003; Maury 2006) => Alignment effect.

�Conversely, family firms have lower performance (Holderness and Sheehan 1998) => Entrenchment effect.

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Prior Studies: Ownership Structure & CG�Small board sizes have higher stock market value

than large board sizes (Yermack 1996; Mishra 2001 ).�Independent director bears a significant and �Independent director bears a significant and

positive relation to performance in firm with founding family ownership (Anderson and Reeb 2004).

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Prior Studies: Ownership structure & EM� Family firms is negatively associated with

absolute abnormal accrual (Warfield et.al, 1995; Wang 2006)Wang 2006)

� Audit committees in family firms play a significant role in constraining earnings management (Jaggi and Leung 2007)

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Prior Studies: Ownership structure & CompensationChen et. Al. (WP 2002)� Family ownership reduces the consumption of

managerial perquisites.managerial perquisites.

� Within Family firms, founder - and hired -CEOs consume LESS and the decendent -CEOs MORE, perks .

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4: Theory Development

Concentration ownership

Widely held

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Agency Theory Entrenchment effect

(Anderson and Reeb (2003))

Manager and shareholders

Controlling shareholder

and MI

Alignment effect

(Anderson and Reeb (2003))

4.1 Agency Theory� Jensen and Meckling (1976) model is the contract of

an agency relationship between principal and agent.

� Agency problem� the effort� the effort� perquisite problem� different horizon� different risk preferences

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4.2 Entrenchment effectOwnership is concentrated to level at which an owner

obtains effective control of the firm� Agency shift away from manager-shareholders conflict to

conflict between the controlling owner (who is often also manager) and minority shareholders.manager) and minority shareholders.

� Controlling shareholder to expropriate wealth from other shareholder (Fama and Jensen (1983), Morck et al. (1988) and Shleifer and Vishny (1997).

� Founding family have the incentive and power to take action that benefit themselves at the expenses of the firm performance (Anderson and Reeb (2003).

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4.3 Alignment effect� Concentration ownership have substantial economic

incentive to diminish agency conflicts and maximize firm value (Demsetz and Lehn (1985)

� Family’s wealth is so closely linked to firm welfare (Demsetz � Family’s wealth is so closely linked to firm welfare (Demsetz and Lehn (1985)

� Strong incentive to monitor manager (Anderson and Reeb (2003).

� Minimize the free rider problem� Reputation concern (Anderson et al. 2003)

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Hypotheses: H1

Controlling ownership and conservatism

H1:There is a positive relationship between accounting conservatism and controlling shareholder ownership .

H1a:There is a positive relationship H1a:There is a positive relationship between accounting conservatism and FF ownership.

H1b: There is a positive relationship between accounting conservatism and FAM ownership.

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Next: 6 Sub Samples

Controlling Shareholders

Founding Family

(FF)

CEO: Founder

1

CEO: Descendent

2

Shareholders

(CS)CEO: Professional

3Family

(FAM)

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CEO: Founder

4

CEO: Descendent

5

CEO: Professional

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Hypotheses: H2 – CEO Type 1

Family firm management and conservatism

H2: There is a positive relationship between accounting conservatism and CS firms where the CEO is the founder .

H2a: There is a positive relationship 2abetween accounting conservatism and FF firms where the CEO is the founder .

H2b: There is a positive relationship between accounting conservatism and FAM firms where the CEO is the founder .

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Hypotheses: H3 – CEO Type 2

Family firm management and conservatism

H2: There is a positive relationship between accounting conservatism and CS firms where the CEO is the descendent or

relative .

H2a: There is a positive relationship between accounting conservatism and FF firms where the CEO is the descendent .

H2b: There is a positive relationship between accounting conservatism and FAM firms where the CEO is the descendent .

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Hypotheses: H4– CEO Type 3

Family firm management and conservatism

H2: There is a negative relationship between accounting conservatism and CS firms when CEO is hired from outside .

H2a: There is a negative relationship 2abetween accounting conservatism and FF firms when CEO is hired from outside .

H2b: There is a negative relationship between accounting conservatism and FAM firms when CEO is hired from outside .

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5: Research DesignData sources� Listed firms from 2000-2006.� I-SIM CD-ROM and the SET Market Analysis and

Reporting Tool (“SETSMART”).Reporting Tool (“SETSMART”).� Form 56-1.

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Research design – ModelBasu (1997)

Variable Definition

Earnings reflects bad news more quickly then good news

Variable Definition

Earnings/price (Et/Pt-1)

Et/Pt-1, where E is earnings per share and P is beginning of period price per share

Return (R) Stock return for firm i from 10 months before the financial year-end to 2 months after the financial year-end. Stock return is calculated as (Pt – Pt-1)/Pt-1. Share prices have been adjusted from stock splits, new equity issues, etc.

Negative return (RD)

Dummy variable coded 1 if R is negative, zero is otherwise

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Research design – Model

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All of the control variables in the regression are also interacted with RDit and Rit

Research design: variable definition

Variable Definition

OWNt-1(rank) • Equal to the scaled decile rank of percentage of shares held by FF or FAM firms members.

OWNt-110-20% • Dummy variable equal to one if common stock owned by FF or FAM firms members is between owned by FF or FAM firms members is between 10%-20% of outstanding shares at the beginning of the year, zero is otherwise.

OWNt-120-50% • Dummy variable equal to one if common stock owned by FF or FAM firms members is between 20%-50% of outstanding shares at the beginning of the year, zero is otherwise.

OWNt-1>50% • Dummy variable equal to one if common stock owned by FF or FAM firms members is more than 50% of outstanding shares at the beginning of the year, zero is otherwise. 34

Research design – Model

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All of the control variables in the regression are also interacted with RDit and Rit

Research design: variable definition (con’t)

Variable DefinitionF_CEO � Dummy variable equal to one if the CEO is the

founder of the FF or FAM firm, zero is otherwise.

D_CEO � Dummy variable equal to one if the CEO is a descendant of the FF or FAM firm, zero is descendant of the FF or FAM firm, zero is otherwise.

H_CEO � Dummy variable equal to one if the CEO is a hired outsider for the FF or FAM firms, zero is otherwise.

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CG - Control VariablesVariable Definition

DUAL Dummy variable coded one if the CEO is chairman of the board, zero otherwise.

BRDSIZE Number of directors on the board at the year-end

IND Number of independent audit committee divided IND Number of independent audit committee divided by total board size.

BIG4 Dummy variable coded one if the firm’s auditor is a big-four firm, zero otherwise.

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Firm Characteristics: control variablesVariable Definition

LEVt-1 Scaled decile rank of total debts divided by total assets at the beginning of the fiscal year.

PINSTt-1 Institutional share ownership as a percentage of the total number of outstanding shares at the year-end.

SIZEt-1 Scaled decile rank of market value of equity divided by total assets at the beginning of the fiscal year.

RISK Dummy variable coded one if the firm is a technology industry, zero otherwise.

MTBt-1 Scaled deciles rank of the market-to-book ratio at the beginning of the fiscal year. Shareholder equity at the beginning of the fiscal year is deducted from revaluation surpluses at the beginning of the fiscal year

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6: Results -- Sample

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Descriptive Statistics

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Proportion of CS and Non-CS

CS95.5%

Non-CS4.5%

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95.5%

CS-FF60.5%

CS-FAM35.0%

Non-CS4.5%

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Table 5

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Table 6

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Table 6 (con’t)

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Table 7

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Table 7 (con’t)

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7. Implications� FF and FAM firms are more like to forgo short-term

benefit from less conservatism because of the incentive to pass on their business to future generation and to protect the family’s reputation.

� FF firms, founder, descendent and professional CEO and � FF firms, founder, descendent and professional CEO and FAM firm, founder and professional CEO are associated with more conservatism earnings because they can enhance firms’ wealth, possess special expertise and intentions of long-term presence.

� The result might be generalized to other capital markets in East Asia Region.

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Q&A

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Thank You