Profitability Management and the Effects of Size of Company, Ownership Structure and Corporate governance

Journal of Accounting Advances (J.A.A)
Vol. 3, No. 2, Fall & Winter, 2012, Ser. 61/3
 
 
Extended Abstract
 
Profitability Management and the Effects of Size of Company, Ownership Structure and Corporate governance
 
Dr. A. Ahmadpour                                     H. Montazeri
Mazandaran University
 
Introduction
There are two types of earnings management: efficient and opportunistic. Earnings management is efficient if managers use their discretion to communicate private information about firm profitability, while it is opportunistic if managers use their discretion to maximize their utility, thereby garbling earnings.
 
Firm Size:
Managers of small companies are able to retain their private information more successfully than managers of large companies. As firm grows in size, the information on that firm becomes more publicly available which makes more difficult for large firms to manage earnings opportunistically than for small firms.
 
Ownership structures:
Family-controlled firms should be more efficient than publicly-owned firms because monitoring costs are lower in family-owned firms. Nonetheless, for firms belonging to business groups, owners may motivate by opportunistic behavior to expropriate minority shareholders. We suggest that firms with high family ownership and no business groups should be able to limit opportunistic earnings management.
Institutional ownership in an entity provides strong incentive for investors to actively monitor and influence managements' policy for that entity. They could identify earnings management faster and easier than non-institutional investors. Therefore, we expect that Institutional investors be able to limit opportunistic earnings management.
 
Corporate governance:
We argue that the existence of corporate-governance practices in a firm will limit opportunistic earnings management. In our study we employ audit quality and independent board members, as proxies for corporate-governance practices.
Auditors' Independence and Audit quality will increase when they are selected by independent board members. So, it's more likely, they are able to discover and report a breach in the client's accounting system. This suggests that high audit quality should limit opportunistic earnings management.
One of the independent board members tasks is ensuring a firm's financial statement's transparency and faithfulness. Independent board should notice that management could deal with earnings management. So they should monitor managers' opportunistic behavior. We expect that higher the proportion of independent board members will restrain opportunistic earnings management.
 
Research hypotheses
This research includes six hypotheses as follows:
1: There is a relationship between discretionary accruals and future profitability.
2: Effect of discretionary accruals in future profitability is more in firms with family ownership and no business groups than other firms.
3: The more the share of investing institutions in property, the more the effect of discretionary accruals in future profitability
4: Effect of discretionary accruals in future profitability is more on firms with larger value of capital market than smaller firms.
5: Effect of discretionary accruals in future profitability increases on firms audited by large auditioning institutes than firms audited by other auditors.
6: Higher shares of independent board members results in higher effects of discretionary accruals in future profitability.
 
Methods
Our samples consisted of 119 companies which have been involved in TSE from 1382 to 1387. We used multiple regressions to examine hypotheses. In order to test the first hypothesis, regression model (1) was used as follows:
 
X_it+1 = β₀ + β₁ CFO_it + β₂ DFAM_it + β₃ INST_it + β₄ BOD_it + β₅ DSIZE_it + β₆ AUDIT_it + β₇ NDAC_it+ β₈ DAC_it + e_it
 
If the type of earnings management is efficient, the coefficient (β₈) will be positive. Otherwise, it will be either zero, negative or insignificant.
In order to test the second to sixth hypotheses, regression model (2) was used as follows:
 
X_it+1 = β₀ + β₁ CFO_it + β₂ DFAM_it + β₃ INST_it + β₄ BOD_it + β₅ DSIZE_it + β ₆ AUDIT_it + β₇ NDAC_it + β₈ DAC_it + β₉ DAC_it × DFAM_it + β₁₀ DAC_it × INST_it + β₁₁ DAC_it × BOD_it + β₁₂ DAC_it × DSIZE_it + β₁₃ DAC_it × AUDIT_it + e_it
 
It's expected in regression (2) that β_{9 - 13} > 0
We used two measures of future profitability (X_t+1 = ΔEARN_t+1 or CFO_t+1). Evidence offer which CFO is the most reliable because it does not include any discretionary accrual components. Therefore we offer our results based on CFO.
Also we used 4 models to decompose total accruals into discretionary accruals (DAC) and non discretionary accruals (NDAC) components. Based on the adjusted R², the model of Kasznik (1999) was selected.
 
Results
Results of estimating model (1):
Results show that among all variables in the model, CFO, DAC and NDAC are significant in the confidence level of 95%. The Coefficient (β8) is positive for DAC variable.
 
Results of estimating model (2):
Results show that among all variables in the model, CFO, DFAM, NDAC, DAC*DFAM and DAC*DSIZE are significant in the confidence level of 95%. The Coefficients β₉ andβ₁₂ are positive for DAC*DFAM and DAC*DSIZE variables respectively.
 
Conclusion
Results indicate efficient earnings management implications. It was also determined there is a significant relationship between firm size, high family ownership and no business groups and managers tendency in selecting the type of earnings management. In other words these two variables are the factors that force managers to use efficient earnings management or prevent them for using opportunistic earnings management. Also evidence does not offer any significant relationship between independent board members, institutional ownership, quality of independent auditor and the tendency of managers in selecting earnings management.