Valuation of Family Firms: The Limitations of Accounting Information

Abstract

This conceptual paper explores the extent to which reported accounting information captures unique family firm decision-making and intangible asset factors that impact financial value. We review the family firm valuation-relevant literature and identify that this body of research is predicated on the assumption that accounting information reflects the underlying reality of family firms. This research, however, fails to recognise that current accounting technology does not fully recognise the family firm factors in the book value of the firm or the implications for long run persistence of earnings. Thus, valuation models underpinning the extant empirical research, which are predicated on reported accounting information, may not fully reflect the intrinsic value of family firms. We present propositions on the interaction between accounting information, family factors and valuation as a road map for future empirical research with a discussion of appropriate methodologies.

Earnings Management in Public Family Firms under Economic Adversity

“…This result is an indication that FF present higher earnings quality than NFF, suggesting that FF are less motivated to earnings management practices than NFF, which is in line with the results of several authors, such as Prencipe et al (), Jiraporn and DaDalt (), Murphy et al (), Ghabdian et al (), Paiva and Lourenço () and Achleitner et al (). Specifically, our finding seems to be consistent with the alignment hypothesis (Jensen and Meckling ; Fama and Jensen ; González and García‐Meca ), as well as with the long‐term orientation of FF (Anderson et al ; Gomez‐Mejia et al ; Jiraporn and DaDalt ; Salvato and Moores ) and the desire to pass firms onto succeeding generations (Berrone et al ; Hasso and Duncan ; Achleitner et al ), expanding the future earnings streams time horizon. Compared with NFF, FF are more concerned to accumulate and preserve their wealth over time.…”

“…This result is in line with Ball and Shivakumar (), who find no significant earnings management practices in UK firms, and with González and García‐Meca (), who find no significant relationship between FF and discretionary accruals. It suggests a compensation between the alignment hypothesis (Jensen and Meckling ; Fama and Jensen ; González and García‐Meca ), the long‐term orientation of FF (Anderson et al ; Gomez‐Mejia et al ; Jiraporn and DaDalt ; Salvato and Moores ) and the desire to pass firms onto succeeding generations (Berrone et al ; Hasso and Duncan ; Achleitner et al ) and, on the other hand, the entrenchment effect (Fama and Jensen ; Shleifer and Vishny ; Anderson and Reeb ). According to the alignment hypothesis, the long‐term orientation of FF and the desire to pass firms onto succeeding generations, it is expected that FF are less likely to manage earnings than their counterparts.…”

“…The alignment effect can be reinforced by evidence that family firms have a long‐term orientation in business (Anderson et al ; Gomez‐Mejia et al ; Jiraporn and DaDalt ; Salvato and Moores ) and the desire to pass firms onto succeeding generations (Berrone et al ; Hasso and Duncan ; Achleitner et al ), expanding the future earnings streams time horizon. Their main concerns are associated with keeping the trust of the controlling shareholder and not only the firm's earnings (Prencipe et al ).…”

“…Considering these arguments, we expect that family‐controlled firms are less worried about short‐term performance and earnings volatility and, consequently, are less likely to manage earnings in order to smooth income. As a result, the alignment effect predicts that family firms have fewer incentives to manage earnings than non‐family firms, reporting higher quality earnings, namely to protect long‐term firm performance and establish and maintain a favourable reputation (Sraer and Thesmar ; Gomez‐Megia et al ; Jiraporn and DaDalt ; Salvato and Moores ; Hasso and Duncan ; González and García‐Meca ). Wang (), Ali et al () and Jiraporn and DaDalt () conclude that US family firms are less likely to manage earnings than non‐family firms, consistent with the alignment effect of family ownership.…”

“…Thus, the directional relationship between family firms and earnings management becomes an empirical question. Based on the alignment hypothesis (Jensen and Meckling ; Fama and Jensen ; González and García‐Meca ), and on the evidence that family firms have a long‐term orientation in business (Anderson et al ; Gomez‐Mejia et al ; Jiraporn and DaDalt ; Salvato and Moores ) as well as the desire to pass firms onto succeeding generations (Berrone et al ; Hasso and Duncan ; Achleitner et al ), we formulate the first hypothesis: H1: The incentive to manage earnings is stronger for non‐family controlled firms than for family controlled firms . …”