How Does Regulation Affect the Relation Between Family Control and Reported Cash Flows? Comparative Evidence from India and the United States

Abstract

Manuscript Type Empirical. Research Question/Issue We conduct a two‐country study to understand (i) how family and non‐family firms engage in classification shifting to manage reported operating cash flows in each country; (ii) how this behavior varies between the two countries; and (iii) how corporate governance regulation introduced independently in each country moderates the observed behavior. Research Findings/Insights We find that family ownership has different effects on quality of cash flow reporting in the two countries. Furthermore, country‐level regulation moderates these effects differently. In particular, (i) firms in both countries engage in manipulating operating cash flows, but the evidence is stronger in the United States; (ii) family firms in India engage in more shifting than non‐family firms, but this is not observed in the United States; and (iii) family (non‐family) firms in India increase (reduce) shifting, whereas only non‐family firms in the United States increase shifting after regulation. Since non‐family firms in India raise more external capital than family firms after regulation, we infer that family firms in India reacted to this competition for capital and resorted to shifting. Theoretical/Academic Implications Most studies assume that the incentives for family firm behavior are the same in different market settings. However, factors such as efficiency of public capital markets, enforcement of corporate laws and regulations, and other institutional practices can cause differences in family firm behavior across different market settings. We investigate the behavior of family and non‐family firms in each of these markets and study how a feature of the national governance system, regulatory design, moderates this behavior. Practitioner/Policy Implications Our findings should be useful to global investors and regulators in both emerging and developed markets. The results indicate how similar regulation in the two different settings can trigger differences in the behavior of firms.

Does good corporate governance constrain cash flow manipulation? Evidence from India

“…Consequently, Indian firms are likely to engage in cash flow manipulation. However, the magnitude of such misclassification is lower in India as compared to that in the USA (Nagar and Sen, 2016).…”

Advancing the Corporate Governance Research Agenda

“…It is also shown that these institutional variations accordingly play a critical role in explaining cross‐national differences in corporate governance mechanisms (Adams, Licht, & Sagiv, ; Hooghiemstra, Hermes, & Emanuels, ; La Porta, Lopez‐de‐Silanes, & Shleifer, ; La Porta, Lopez‐de‐Silanes, Shleifer, & Vishny, ). For instance, a recent stream of research has addressed corporate governance in emerging economies such as China and India, whose institutional environments are less developed or quite different from those of advanced economies (Chen, Liu, & Lin, ; Huyghebaert & Wang, ; Lattemann, Fetscherin, Alon, Li, & Schneider, ; Li, ; Nagar & Sen, ; Singh & Gaur, ; Zhang, Chen, & Feng, ; Zhang, Gao, Guan, & Jiang, ). It is claimed that business groups are an organizational form that can overcome market imperfections prevalent in emerging economies (Colpan, Hikino, & Lincoln, ; They exhibit unique governance challenges as well as attributes to overcome broader strategic issues such as institutional voids or competitiveness, as summarized by Colli and Colpan's () article in this special issue.…”

Corporate social responsibility and operating cash flows management: An examination of credit market incentives

“…Third, as described previously, a growing stream of literature documents that firms inflate reported CFO when they have incentives to do so (e.g., Gordon et al., 2017; Lee, 2012; Nagar & Sen, 2016). Collectively, this line of research suggests that firms manage CFO upward in response to incentives.…”

“…(2017) extend findings of Lee (2012) by showing that European firms with similar incentives are more likely to make classification choices to enhance reported CFO. Comparing the levels of CFO management between US and Indian firms, Nagar and Sen (2016) find that the magnitude of CFO management is higher for firms in India, which they characterize as having weaker corporate governance and investor protection, as compared to those in the United States.…”