Unlisted family firms represent over 99% of all companies in the EU, and generate over 75% of the GDP for Europe. Their strategic choices are shaped by the relative level of socioemotional wealth (SEW). In other words, in decision making, these enterprises take into account not only economic factors, but also considerations like identity, the ability of the family to exercise control over the company, the creation of social relationships, the emotional attachment of the family to the company, and the continuation of the family dynasty.
Preserving SEW is the motivation underpinning financial reporting decisions, potential manipulation of reported results and the level of accounting disclosure transparency. With regard to unlisted firms, these organizations are generally less subject to controls compared to their listed counterparts. This makes it easier to choose whether to strategically manipulate earnings and how, even though such a decision is never risk free, in particular in this context.
To avoid or prevent potential threats, family firms could even make less-than-optimal business decisions to influence the representation of the company’s financial position as reflected in its financial reporting, which is the primary source of information for third parties. For unlisted firms, in fact, the quality of reporting affects organizational reputation significantly. In addition, these companies are highly dependent upon outside sources of financing, mainly from banks, which base their credit risk assessments and the cost of debt on reporting quality. Furthermore, balance sheets are generally the starting point for strategies such as IPOs or acquisitions. Since unlisted family firms have no access to capital markets, most likely their reporting is also strongly shaped by policies regarding dividends and limiting the tax burden. Finally, without any measurements of firm value based on market dynamics, quality reporting becomes particularly relevant to evaluate company performance.
In our recent study, we examine the question of whether different levels of SEW impact the quality of financial information provided by unlisted family firms. In particular, we analyzed Italian companies that voluntarily adopted International Financial Reporting Standards (IFRS), which require greater information transparency compared to national accounting principles. Our research specifically sought to investigate whether earnings manipulation strategies during the transition to IRFS by certain unlisted national firms could be framed within the context of preserving socioeconomic wealth. To manipulate financial information, companies can utilize two main strategies:
The second type of manipulation could have a negative impact on financial performance and future profitability. Moreover, this strategy is more difficult to detect because auditors do not pass judgment as to whether the business decisions of the companies they inspect are sound.
In order to investigate the possible existence of a relationship between SEW endowment and earnings manipulation strategies, we utilized a sample of unlisted Italian companies that voluntarily adopted IFRS from 2005 to 2011. We compared this sample with a control group made up of similar firms which did not adopt IFRS. The choice of unlisted firms is significant because in Italy, such enterprises carry tremendous economic weight: SMEs (for the most part family firms) account for 40% of this country’s GDP and constitute 93% of all national businesses.
Our findings reveal a negative relationship between SEW endowment and accrual earnings manipulation. Specifically, in companies with low socioemotional wealth (for example, when the family has little control over the firm and/or does not identify with it), family members are more interested in preserving their dominant (albeit weak) position and legitimizing their control. Therefore, instead of opting for real activity manipulation, which might have negative repercussions on future business performance, they tend to choose accrual manipulation. Our study also finds a positive relationship between SEW endowment and real activity manipulation. Indeed, family firms with high levels of SEW are more interested in safeguarding the company’s reputation. So if they should decide to manipulate earnings, they would be more inclined to choose the second type of manipulation, which would be harder to detect, thus less of a risk to the company’s reputation. Beyond a doubt, in situations that have the potential to modify incentives to manipulate corporate earnings, unlisted family firms choose manipulation strategies while factoring in potential reputational damage that such tactics could cause.
It may be interesting to document how a family’s SEW endowment impacts the quality of their company’s financial information, seeing as this is the basis for decision making for various stakeholders. For example, banks would want to peruse financial information when deciding whether to grant a loan to a family firm, as well as the cost of debt.
Furthermore, there may also be practical implications for corporate governance. Since the board of directors for a family firm tends to be less independent, family members could secure approval for suboptimal economic decisions, for the sole purpose of manipulating the earnings reported in the financial statements. An effective corporate governance of family firms could consider SEW endowment when evaluating and activating mechanisms for monitoring accounting information provided to stakeholders.
Per conoscere le variabili di mercato, prevederne gli andamenti e governare i rischi nell’ambito della finanza corporate.
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