Academic journal article Australasian Accounting Business & Finance Journal

Ownership Structure and Earnings Management: Evidence from Portugal

Academic journal article Australasian Accounting Business & Finance Journal

Ownership Structure and Earnings Management: Evidence from Portugal

Article excerpt

Abstract

This paper examines the relationship between corporate ownership structure in Portugal and earnings management. The Portuguese governance structure is characterised by the dominance of the largest shareholder who typically exercises significant influences on management decisions directly or indirectly. Existing literature suggests that ownership structure decreases the incentive to manage earnings but also provides the opportunity and incentive to manipulate earnings. Therefore, the main purpose of this paper is to analyse whether a firm's ownership structure (measured with three variables: managerial ownership, ownership concentration and institutional ownership) exacerbate or alleviate earnings management. Using a sample of 34 non-financial listed Portuguese firms for years from 2002 to 2007, we find that discretionary accruals as a proxy for earnings management is negatively related both to managerial ownership and to ownership concentration. The study's results suggest that both managerial ownership and ownership concentration improve the quality of annual earnings by reducing the levels of earnings management.

Keywords: Earnings management, Discretionary accruals, Ownership structure, Ownership concentration.

JEL Classification: M410, G32, G34.

(ProQuest: ... denotes formulae omitted.)

Introduction

In a world characterised by imperfect information and costly monitoring, a divergence of interests between shareholders and management can lead to suboptimal management decisions. Such decisions are possible because the actions of managers are largely unobservable and the goals of the managers and their shareholders are not necessarily aligned. Managers are posited to opportunistically manage earnings to maximise their utility at the expense of other stakeholders. Agency theory suggests that the monitoring mechanisms can improve the alignment of management and shareholders' interests and mitigate any opportunistic behaviour resulting from conflict of interests.

Accounting earnings is considered as one of the main indicators of financial performance of a firm. Naturally, the phenomenon of earnings management has already drawn the attention of academic researchers, financial markets regulators, operators and investors.

Previous studies have focused mainly on the incentives of earnings management. The most important incentives investigated in prior literature include: compensation contracts (Guidry, Leone & Rock 1999; Healy 1985; Holthausen, Larcker & Sloan 1995), reduce political costs (Key 1997; Watts & Zimmerman 1986), signal manager's private information (Healy & Papepu, 1995), avoid losses (Burgstaher & Bichev 1997), meet analysts' forecasts (Athanasakou, Strong & Ealker 2009; Kasznik 1999), avoid debt covenant violations (DeFond & Jiambalvo 1994), initial public offerings (Teoh, Welch & Wong 1998a), seasoned equity offerings (Teoh, Welch & Wong 1998b) management buyouts (DeAngelo 1986; Perry & Williams 1994) and stock-financed acquisitions (Erickson & Wang 1999).

However, there exists a variety of factors that limit earnings management. In fact, some studies have indicated that certain corporate governance factors have an impact on corporate accounting behaviour, including earnings management (Dechow, Sloan & Sweeney 1996; Dempsey, Hunt & Schroeder 1993; Jiambalvo 1996). For example, Warfield, Wild and Wild (1995) argue that managers who own a significant portion in the equity of a firm have less incentive to manipulate reported accounting information. Dechow et al. (1996) suggest that large block-holders of shares improve credibility of a firm's financial statements by providing close scrutiny over its earnings management activity. Balsam, Bartov and Marquardt (2002) state that institutional investors, who are sophisticated investors, are more capable of detecting earnings management than non-institutional investors because they have more access to timely and relevant information. …

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