Accounting Research Journal

Consequences of earnings management for corporate reputation: Evidence from

family firms
Lázaro Rodriguez-Ariza, Jennifer Martínez-Ferrero, Manuel Bermejo-Sánchez,
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Consequences of earnings Consequences

of earnings
management for management
corporate reputation
Evidence from family firms 457
Lázaro Rodriguez-Ariza Received 20 February 2015
Universidad de Granada, Granada, Spain Revised 17 April 2015
Accepted 26 May 2015
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Jennifer Martínez-Ferrero
Multidisciplinary Institute for Enterprise (IME), University of Salamanca,
Salamanca, Spain, and
Manuel Bermejo-Sánchez
IE Business School, Madrid, Spain

Abstract
Purpose – Based on earnings management (EM) practices, the purpose of this research is to analyze
their market social consequences on corporate reputation. Moreover, this paper illustrates this impact in
the context of family firms which are led and controlled by family members, whose main interest is the
long-run survival through succession.
Design/methodology/approach – A sample comprising 1,169 international listed companies for the
period 2006-2010 was used.
Findings – The empirical evidence shows the negative impact of these discretionary accounting
practices on corporate image. However, family firms have more incentives for controlling and
monitoring managerial decisions, avoiding information asymmetries and, thus, EM behavior and their
subsequent loss of reputation. Therefore, fewer negative effects on corporate reputation are observed in
highly concentrated ownership structures as a result of the negative link between family control and
EM.
Originality/value – This study presents a number of contributions because of its focus on specific
discretionary practices and on family firms. This study contributes to previous literature on family
firms, as previous papers do not tend to focus on EM issues. Moreover, in contrast to most of the studies
that have focused on only one country, we use an international panel database. This leads to potentially
more powerful and generalized results. In addition, this paper is the first attempt (to the authors’
knowledge) to study the possible impact of EM on corporate reputation in the family firm context.
Keywords Empirical research, Family firms, Earnings management, Corporate reputation
Paper type Research paper

1. Introduction
The surge of accounting scandals in recent years, coupled with continual corruption
cases, the falsification of accounts, illegal funding, creative accounting and many other Accounting Research Journal
issues, led us to analyze the existence of such discretionary practices, in this case, Vol. 29 No. 4, 2016
pp. 457-474
earnings management (EM), understood as “any practice intentionally carried out by © Emerald Group Publishing Limited
1030-9616
company managers, for opportunistic and/or information purposes, to report DOI 10.1108/ARJ-02-2015-0017
 ARJ accounting results that do not correspond to those really achieved” (García-Osma et al.,
29,4 2005, p. 2).
According to Zahra et al. (2005), the consequences of these discretionary behaviors
affect investors, employees, customers and local communities, and are eventually
reflected in corporate reputation and hence market value. In this respect, this paper
focuses on analyzing the consequences of EM practices on corporate reputation because
458 of these discretionary practices that could affect the value of companies, their
stakeholder relationships, reputation and corporate image (Fombrun et al., 2000;
Roychowdhury, 2006).
However, we extend previous research, as an organization may present both internal
and external characteristics that could either increase or moderate managerial
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discretion such as EM (Finkelstein and Hambrick, 1990). One such characteristic is the
degree of ownership concentration; managers can be more closely monitored when there
is a clear separation between ownership and control. Accordingly, in the present study,
the question of family ownership is taken as an internal control mechanism of EM, as
values, goals and motivations can differ notably between family and non-family firms
(Zahra et al., 2005). Such firms are characterized by the family’s power in ownership,
management, governance and succession, as well as in the definition of the company’s
objectives and strategies (Chrisman et al., 2004; Chua et al., 1999; Déniz and Suárez,
2005).
So, the aim of this paper is to analyze the market and social consequences of EM for
corporate reputation and if this effect could be moderated by family ownership as an
internal control mechanism that avoids information asymmetries and managerial
discretion. Our empirical analysis will be based on a large sample of international listed
companies from 20 countries, including the Special Administrative Region of Hong
Kong, and covers the period from 2006 to 2010. Methodologically, we will use a logit
model with marginal effects on the panel data.
This study contributes to the existing literature in several respects. In particular, it
offers in-depth analysis of the causes and consequences of discretionary practices in
general and of EM in particular, in a specific context, family ownership as an internal
control mechanism. Our paper is the first attempt (as far as we know) to study the
possible impact of EM on corporate reputation in the family firm context. So, it focuses
on the context of family firms, which are of increasing importance in research. Previous
papers in this respect have placed more emphasis on leadership, ownership and
succession-related topics (Materne et al., 2013; Benavides-Velasco et al., 2013), and have
neglected discretionary issues. Furthermore, using an international sample for the
period 2006-2010 provides more applicable results in relation to other countries. In
contrast to the majority of studies which focus on only one country, we use an
international sample of 21 countries, thus obtaining potentially more powerful and
generalizable results. Moreover, the study’s consideration of the temporal dimension of
data, particularly in periods of great change, enriches its perspective. In this regard, the
panel data obtained enable us to control for year-on-year effects that may affect
sustainable practices.
In the next section, we discuss the extant literature and establish a set of testable
hypotheses. This is followed by a section in which we describe the sample, variables and
empirical methodology used to test the hypotheses. We then present the results of our
empirical analysis and discuss the overall results. The concluding section summarizes
 the main findings, points out the limitations of this study and suggests lines for possible Consequences
future research. of earnings
management
2. Earnings management and its consequences for corporate reputation
in family firms: research hypotheses
2.1 Earnings management and corporate reputation in family firms
The separation between ownership and control can be considered as the starting point of 459
EM, which is viewed in terms of a variety of agency costs (Davidson et al., 2004). In EM,
company directors, acting for their own benefit, not only carry out actions that are
detrimental to shareholders’ interests in the form of non-optimal investment decisions,
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but also actions aimed at influencing contractual outcomes that are injurious to other
interest groups (Healy and Wahlen, 1999). These practices violate the basic
characteristics of financial reporting quality: relevance, reliability, transparency and
clarity (Jonas and Blanchet, 2000).
A wide variety of reasons have been presented as incentives for managers to
manipulate accounting results. As noted by Gargouri et al. (2010), such reasons can
include the wish to smooth out income flows, to minimize the tax burden, to effect
changes in the control of the company, to influence labor negotiations or to respond to
takeover bids. Healy and Wahlen (1999) grouped these motivations as contractual,
political/governmental and valuation-based.
The consequences of these management practices are beyond doubt detrimental,
reducing the value of the company, its assets, its transactions, its reputation and
corporate image (Fombrun et al., 2000), and at the same time provoking a loss of
support among shareholders, investors and other stakeholders, and increasing
activism and surveillance by interest groups and regulatory authorities (Zahra et al.,
2005). Specifically, we focus on the consequences of EM practices for company
reputation, one of the detrimental results of this discretionary strategy, as
reputation depends on the information received by the public about that company’s
behavior, via the press, the market or the company itself (Brammer and Pavelin,
2004).
Fombrun et al. (2000) and Roychowdhury (2006) point out the negative impact of
unethical accounting practices on the value of companies, their transactions, their
reputation and their corporate image; they also lead to loss of support from investors
and other stakeholders, increased activism and surveillance by interest groups and
regulatory authorities, damage to corporate reputation and financing constraints
(Fombrun et al., 2000). Lower corporate reputation as a consequence of EM practices
not only affects companies but also entails an individual loss of management
reputation (Zahra et al., 2005) when accounting scandals or EM practices come to
light.
In this paper, we analyze the detrimental effect of EM practices on companies’
corporate reputation and extend previous literature because an organization may
present both internal and external characteristics that could either increase or moderate
EM (Finkelstein and Hambrick, 1990).
One such characteristic is the degree of ownership concentration; managers can be
more closely monitored when there is a clear separation between ownership and control.
Accordingly, in the present study, the question of family ownership is taken as an
 ARJ internal control mechanism of managerial discretion such as EM, as values, goals and
29,4 motivations can differ notably between family and non-family firms (Zahra et al., 2005).
Following Miller and Le Breton-Miller (2003, p. 127), the family firm can be
defined as:
[…] one in which a family has enough ownership to determine the composition of the board,
where the CEO and at least one other executive is a family member, and where the intent is to
460 pass the firm on to the next generation.
For Basu et al. (2009), some of the main features of family firms are the long-term
approach of family owners, the objective of maintaining their wealth in the company,
their active participation in management and the definition of strategies and objectives
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and their role on the board and upon intergenerational transfer. What makes a family
firm unique is the influence of a family or family group in the ownership, management,
governance and succession, as well as in the definition of the company’s objectives and
strategies (Chua et al., 1999; Déniz and Suárez, 2005).
One of the strategies possibly influenced by the strong presence of family is the use
of EM practices. Greater managerial ownership decreases the conflict of interest
between owners and agents. Thus, most studies have reported that in family firms, there
is less managerial incentive to carry out EM practices (Chen, 2006; Khan et al., 2013;
Landry et al., 2013). Family ties are associated with fewer incentives to engage in
discretional practices and a lower risk that managers will act to their own benefit (Ali
et al., 2007) as a consequence of the better alignment of interests between family
members and other shareholders (Warfield et al., 1995). According to this perspective,
the greater the family ownership, the greater the incentive to monitor and control
managerial decisions more widely and more effectively. A number of studies, such as
those by Fields et al. (2001), Wang (2006), Ali et al. (2007) and Landry et al. (2013), have
provided evidence that family firms allow owners to participate actively in controlling
and monitoring the management of directors and there is less likelihood of manipulating
earnings. One of the possible reasons for this is the long-run orientation of such firms
and their intention to preserve their corporate reputation and their family name,
avoiding accounting and financial scandals. Family managers and family owners have
incentives to avoid any actions that could damage the reputation of the firm and their
own reputations, and to keep the family’s honor intact (Block, 2010). They are
emotionally connected to the company (Astrachan and Jaskiewicz, 2008).
Although there is very little or no literature on family business and reputation,
resource-based theory provides the necessary theoretical framework to understand and
justify why family firms may enjoy competitive advantage associated with certain
resources and capabilities, among which are their reputation and organizational
identity. So, do family firms enjoy a better corporate reputation among their
shareholders and other stakeholders?
Resource-based theory – applied to the specific case of family firms – allows
understanding of how companies with ownership highly concentrated in the hands of a
family identify and develop their capabilities and skills and then transfer them to their
successors (Chrisman et al., 2003). As described by Habbershon and Williams (1999),
enhancing corporate reputation is one of the processes in which businesses can engage
to achieve a capacity that confers a competitive advantage and ultimately impacts
positively on performance. According to Cennamo et al. (2012), family firms frequently
 manage their organization in relation to business reputation and identity objectives, as Consequences
well as aiming for social legitimacy, and these goals give them reasons to work in the of earnings
interest of stakeholders (customers and suppliers, among others). Precisely because
family members identify reputation with survival, they not only manage and guide their
management
company in terms of monetary aspects but also maintain a program aimed at gaining
social legitimacy and enhancing their reputation, for example, through socially
responsible practices (Dyer and Whetten, 2006). Thus, they seek to achieve a legitimacy 461
which will build a better corporate image as perceived by the market, investors and
other stakeholders. Similarly, Kashmiri and Mahajan (2010) contribute to this sparse
literature by showing the interest and concern of family firms to safeguard and protect
their corporate reputation and identity. Together with one of the main characteristics of
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family firms – their long-run horizon – Gibbons and Murphy (1991) show how the
orientation to and concern with reputation is positively related to the long term.
In view of the above arguments, our hypothesis suggests a moderation of the
negative impact of EM actions on reputation based primarily on two aspects. First, the
greater control and monitoring that family shareholders exert in managerial decisions
avoids the promotion of discretionary practices such as EM. Second, and based on
resource-based theory, family firms enjoy competitive advantage in relation to certain
aspects, such as social capital (reputation), as it is an important organizational asset
(Fombrun, 1996). Family firms often aim to ensure a strong corporate image and
reputation (Cennamo et al., 2012; Dyer and Whetten, 2006). Thus, the following
hypothesis is proposed:
H1. The impact of EM on corporate reputation can be moderated in family firms.

3. Methodology
3.1 Population and sample
The sample used to test the proposed hypotheses comprises 1,169 international
non-financial companies listed for the period 2006-2010. In line with La Porta et al.
(2002), we exclude financial firms due to the different characteristics of their equity and
because they are not comparable to non-financial firms. The sample is unbalanced,
consisting of 5,500 observations obtained from 20 countries, including a Special
Administrative Region (the USA, the UK, Canada, Australia, Germany, The
Netherlands, New Zealand, Austria, Denmark, Finland, Sweden, Switzerland, France,
Italy, Spain, Belgium, Japan, Singapore, Korea and Hong Kong). This sample was
obtained from the fusion of information available in two databases:
(1) Thomson One Analytic databases for accounting, financial and ownership
data – the financial information corresponds to the consolidated data of the
analyzed companies; and
(2) Fortune Magazine for corporate reputation, specifically, from the World=s most
admired companies ranking.

3.2 Corporate reputation

Data on corporate reputation were gathered from Fortune Magazine. We used the
Fortune index, which is a commonly used measure of corporate reputation in several
studies (Fombrun and Shanley, 1990; Melo and Garrido-Morgado, 2012), i.e. the World=s
most admired companies ranking for the period 2006-2010. This is an alphabetical index
 ARJ of the most admired companies drawn from the top 50 surveys and industry rankings
29,4 for each year. This Fortune index is based on questionnaire responses sent to executives,
outside directors and security analysts, and companies are classified with respect to
their competitors using eight attributes of reputation. According to Martínez-Ferrero
et al. (2014), the variable REPUTATION is a dummy variable with the value of 1 for
companies in the World=s most admired companies ranking in that year (and 0
462 otherwise).

3.3 Earnings management measure

EM practices are proxied by management accruals and real measurements to determine
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whether results vary depending on earnings practices. There are two types of EM: pure
accounting decisions, such as accrual-based earnings management (AEM) and real
earnings management (REM), i.e. actions that alter the timing and scale of production,
sales, investment and financing activities throughout the accounting period in such a
way that a specific earnings target can be met (Roychowdhury, 2006). Managers can
choose between AEM and REM actions depending on which ones are less costly and less
visible to investors and to the market (Kim et al., 2012). According to Zang (2012),
decisions regarding EM by means of “real” actions precede decisions regarding EM by
means of accruals.
Traditionally, studies have focused on AEM because it is a less costly means of
misleading investors and is thus preferred by managers seeking to meet income targets,
whereas REM could be detrimental to firms’ competitiveness and future value (Osma,
2008). However, it has been suggested that the manipulation of real activities is also
widespread (Graham et al., 2005) because it is harder for auditors and regulatory bodies
to detect REM than AEM, as REM is linked to operating, investing and financing
activities (Cohen and Zarowin, 2010). This research analyzes the two options that
executives have to manage accounting results. The objective of this analysis is to
demonstrate the possible differences between the aforementioned types of EM
measurement.
3.3.1 Accrual-based earnings management. With respect to EM, the discretionary
component of accruals adjustment could be used as a measure of discretionary
management and, therefore, of accounting manipulation. As not all accruals are
discretionary, it is necessary to separate the discretionary component from the
non-discretionary one to determine the presence and extent of EM. The discretionary
component of accruals adjustment could be used as a measure of EM. Total accruals
adjustment (TAA) has two components, discretionary accruals adjustment (DAA) and
non-discretionary accruals adjustment (NDAA) (García-Osma et al., 2005). TAA is
defined following Jones (1991):

TAAit ⫽ 关 ( ⌬CAit ) ⫺ ( ⌬CASHit ) 兴 ⫺ 关 ( ⌬CLit ) ⫺ ( ⌬RLTPit ) 兴 ⫺ DAit (1)

where ⌬CAit represents the change in current assets for firm i in period t, ⌬CASH
represents the change in cash held and short-term financial investments for firm i in
period t, ⌬CLit is the change in current liabilities for firm i in period t, ⌬RLTPit is the
change in reclassified long-term obligations for firm i in period t and DAit is the
depreciation and amortization for firm i in period t.
 On the basis of equation (1), accruals are calculated using an explanatory model. The Consequences
difference between actual and expected accrual adjustments (taking into account of earnings
growth, company assets and the accounting results) represents the discretionary or
unexplained component of accrual adjustments, and acts as a measurement of
management
management discretion in the reporting of results.
The standard Jones model uses the following procedure to separate the discretionary
component from the non-discretionary component: 463
TAAit
Ai,t⫺1
⫽ ␣1t
1
共 兲
Ai,t⫺1
⫹ ␣2t 共
⌬Salesit
Ai,t⫺1
⫹ ␣3t 兲
PPEit
Ai,t⫺1
⫹ ␧t共 兲 (2)
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where Ai,t⫺1 represents the assets of firm i in period t⫺1; PPEi,t represents the property,
plant and equipment of firm i in period t; and ⌬Sales is the change in sales for firm i in
period t.
NDAAs are calculated by replacing the coefficients in equation (2) with the values
obtained by ordinary least squares (OLS). DAAs are the residuals of this calculation.
In the modified Jones model (Dechow et al., 1995, equation (3)), the TAAs use the
variation in sales minus accounts receivable (which are used to measure the growth of
the company, because its working capital is closely linked to sales), minus the item
property, plant and equipment, which is used to measure the depreciation costs of the
discretionary adjustments. It is assumed that not all sales are necessarily
non-discretionary and that this will depend on the item to be received. Thus:

TAAit
Ai,t⫺1
⫽ ␣1,t 共 兲
1
Ai,t⫺1
⫹ ␣2,t 共
⌬( Sales ⫺ A ⫻ R )it
Ai,t⫺1
⫹ ␣3,t兲PPEit
Ai,t⫺1 共 兲
⫹ ␧t (3)

where A ⫻ R represents accounts receivable, and the other variables are as defined in
equation (2).
It should be noted that the coefficients in this model are calculated in line with the
original Jones (1991) model and that the modification is only made to calculate
non-discretionary adjustments.
3.3.2 Real earnings management. The main models for capturing REM are those
implemented by Roychowdhury (2006) and comprise estimates of abnormal levels of
cash flows from operations, discretionary expenditure (advertising, R&D and selling,
general and administrative) and production costs. Roychowdhury (2006) used the model
by Dechow et al. (1998), which has also been used in other studies in which REM is a
measurement of EM (Cohen and Zarowin, 2010; Kim et al., 2012).
We estimate the normal level of operating cash flows, expenditure and production
costs as follows:

OCFit
Asseti,t⫺1
⫽ ␤0 ⫹ ␤1 共1
Asseti,t⫺1
⫹ ␤2兲 共
Salesit
Asseti,t⫺1
⫹ ␤3 兲 共
⌬Salesit
Asseti,t⫺1
⫹ ␧t 兲 (4)

where OCFit represents firm i’s operating cash flows in year t, which are measured as the
sum of net income, depreciation and amortization, and changes in current liabilities,
minus changes in current assets; Asseti,t⫺1 are firm i’s total assets at the end of year t⫺1;
Salesit are sales during the period t for firm i; ⌬Salesit is firm i’s change in sales from year
 ARJ t⫺1 to year t; and ␧it is the error term. The abnormal OCF is obtained as the residual
29,4 from equation (4). Hence:

DISEXPit
Asseti,t⫺1
⫽ ␤0 ⫹ ␤1
1
共
Asseti,t⫺1
⫹ ␤2 兲
Salesit⫺1
Asseti,t⫺1 共
⫹ ␧t 兲 (5)

464 where DISEXPit represents firm i’s discretionary expenditure in year t; Asseti,t-1 denotes
firm i’s total assets at the end of year t⫺1; Salesit⫺1 are firm i’s sales at the end of year
t⫺1; and ␧it is the error term. Abnormal discretionary expenditure is calculated as the
difference between the actual values (DISEXPit/Assetsi,t⫺1) and the normal level
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predicted in equation (5). Thus:

PRODCOSTSit
Asseti,t⫺1
⫽ ␤0 ⫹ ␤ 1
1
共
Asseti,t⫺1
⫹ ␤2
Salesit
兲
Asseti,t⫺1
⫹ ␤3 共
⌬Salesit
兲 共
Asseti,t⫺1 兲
共 兲
⌬Salesit⫺1 (6)
⫹ ␤4 ⫹ ␧t
Asseti,t⫺1

PRODCOSTSit ⫽ COGSit ⫹ ⌬Invit (6.1)

COGSit
Asseti,t⫺1
⫽ ␤0 ⫹ ␤ 1
1
共
Asseti,t⫺1
⫹ ␤2 兲
Salesit⫺1
Asseti,t⫺1 共
⫹ ␧t 兲 (6.2)

⌬Invit
Asseti,t⫺1
⫽ ␤ 0 ⫹ ␤1 共 1
Asseti,t⫺1
⫹ ␤2 兲
⌬Salesit
Asseti,t⫺1
⫹ ␤3
⌬Salesit⫺1
Asseti,t⫺1共 兲
⫹ ␧t (6.3)

where PRODCOSTSit represents firm i’s production costs in year t, calculated as

(COGSit ⫹ ⌬Invit), where COGSit is firm i’s cost of its goods sold in year t and ⌬Invit is
firm i’s change in inventory from year t⫺1 to year t; Asseti,t⫺1 denotes firm i’s total
assets at the end of year t⫺1; Salesit are sales during period t for firm i; ⌬Salesit
represents firm i’s change in sales from year t⫺1 to year t; and ␧it is the error term. The
residual from equation (6) represents the abnormal production costs.
To obtain a robust measure, we combine these three measurements in a
comprehensive aggregate metrics of REM proposed by Zang (2012). To obtain this
measurement, REM, we multiply the abnormal cash flow from operations and abnormal
discretionary expenses by minus one, and aggregate these into a single measurement.
Then, we aggregate abnormal production costs. In line with Cohen and Zarowin (2010),
we do not multiply PRODCOSTS by minus one because higher production costs, as
noted earlier, are indicative of over-production, which reduces the cost of the goods sold.
We do not combine abnormal production costs and abnormal operating cash flow (CFO)
because, according to Roychowdhury (2006), the same activities that lead to abnormally
high production costs also lead to abnormally low CFO, so combining both amounts
would lead to double counting.
The higher the value of this measure, the more likely the firm is to engage in sales
manipulation and in the reduction of discretionary expenditure to boost reported
earnings. Thus:
 REM 2 ⫽ ( ⫺AbnOCFit ) ⫹ ( ⫺AbnDISEXPit ) ⫹ AbnPRODCOSTSit (7) Consequences
of earnings
With the aim of obtaining robust results, a REM measurement is used as an alternative
to AEM.
management

3.4 Family firms

There are several definitions of family firms in the literature and various 465
operationalizations of these definitions (Uhlaner, 2005). However, most definitions
conclude that family firms are characterized by large investments in capital and
frequently executive representation (Maury, 2006). The explanatory variable of
ownership concentration is FAMILY, which is a dummy variable (Kashmiri and
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Mahajan, 2010; Landry et al., 2013), taking the value 1 if the largest shareholder is an
individual or a family with more than 10 per cent of the votes and 0 otherwise (Mok et al.,
1992; Pindado et al., 2008).

3.5 Control variables

Corporate reputation depends on a number of firm characteristics and without these any
analysis would suffer from omitted variable biases. We control for size, leverage,
operating liquidity and R&D intensity in our econometric models. Company size (SIZE)
is measured by the logarithm of the total assets. The level of firm leverage (DEBT)
represents the debt or non-compliance risk. WORKING_CAPITAL is defined as the
difference between current assets and current liabilities. This reflects liquidity, i.e. a
company’s ability to proceed normally with its activities in the short term. Finally,
R&DINTENSITY is measured by the ratio of R&D expenditure to total revenue.

3.6 Model and analytic technique

To test our hypothesis, we use the following empirical model with the aim of
highlighting the impact of EM on reputation and the moderating role of family firms in
this impact. To attain this aim, REPUTATION is the dependent variable and is
explained by EM, the existence of a family firm (FAMILY) and by the interaction
between these two variables, which represent those family firms that promote EM
practices:

REPUTATIONit ⫽ ø1EMit ⫹ ø2FAMILYit ⫹ ø3EM ⫻ FAMILYit

⫹ ø4Sizeit ⫹ ø5Debtit ⫹ ø6Working_capitalit ( Model A )

⫹ ø7R&DIntensityit ⫹ ␩i ⫹ ␮it

where i represents the company and t represents the time period; ø represents estimating
parameters; ␧i represents the unobservable heterogeneity; and ␮i represents the error
term.
To test the proposed hypotheses, we estimated a logit model with marginal effects for
panel data. Using panel data enables assessment of companies’ performance in the
sample over time by analyzing observations from several consecutive years for the same
companies. Considering the temporal dimension of data, particularly in periods of great
change, enriches the study. More specifically, we estimated our models using logit
methodology. To avoid having dependent variables that may be outside the range of 0
and 1, the solution found among all the possibilities was to use non-linear probability
 ARJ models. These guarantee a result between 0 and 1. Specifically, the binomial or binary
29,4 logistic regression deals with situations in which the observed outcome for a dependent
variable can have only two possible types as in the dependent variable in this study. For
it, logistic regression is used to predict the odds of being a case based on the values of the
independent variables (predictors). The odds are defined as the probability that a
particular outcome is a case divided by the probability that it is a non-case.
466
4. Results
4.1 Descriptive statistics
The descriptive statistics for the main variable in the study are summarized in Table I
and consider both family and non-family firms. Table I shows the absolute and relative
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frequency of family and non-family firms, using a dummy variable with values between
0 and 1. As can be seen, 720 observations (13.09 per cent of the total) relate to family
firms and the other 4,780 observations (86.91 per cent of the total) are of non-family
firms. EM practices are divided into accounting practices (AEM) and real practices
(REM). Furthermore, in terms of AEM practices, non-family firms in the sample have an
average of 24.40179 discretionary accruals, while family firms have an average of
⫺17.303835, indicating the lower tendency to managerial discretion in the case of family
groups. These initial results show a strong tendency to implement EM in both family
and non-family firms. Second, the presence of ownership within the family reduces the
risk of managerial discretion. In relation to REM, non-family firms in the sample have an
average of 17.201674 discretionary accruals, while family firms have an average of
⫺8.256398, indicating the lower tendency to managerial discretion in the case of family
groups. These first results show a strong tendency toward EM in both family and
non-family firms. However, the presence of ownership within the family reduces the risk
of managerial discretion.
Meanwhile, Table I shows a rather lower tendency toward such management in
family firms with their greater control and monitoring power. On the other hand, it
shows a tendency on the part of managers toward accounting actions that are less costly
and less likely to be perceived by investors and stakeholders. The detection of REM
practices could generate strong competitive disadvantages for the company in the long
run.

Non-family firms Family firms

Frequencies
Variables Absolute Relative (%) Absolute Relative (%)

FAMILY 4,780 86.91 720 13.09

REPUTATION 444 9.29 100 13.89

Mean SD Mean SD
AEM 24.40179 3496.49 ⫺7.303835 110.0071
REM 17.201674 1,253.78 ⫺8.256398 235.3652
SIZE 8.135004 1.874847 8.627528 1.933588
DEBT 1.45992 10.81249 1.151114 49.48318
Table I. WORKING_CAPITAL 681.4485 2,143.801 999.1132 2,693.556
Descriptive statistics R&DINTENSITY 0.099643 0.4596115 0.2707921 3.506537
 Regarding REPUTATION, we highlight that the highest percentage of companies Consequences
highly admired by competitors is within the cluster of family business. Only of earnings
approximately 9 per cent of non-family firms are included within the “World=s most
admired companies ranking”, while approximately 14 per cent of the companies located
management
in this ranking are familiar.
With respect to control variables, the average size of non-family firms is 8.135004
(SD ⫾ 1.874847) and the average size of family firms is 8.627528 (SD ⫾ 1.933588), 467
showing that, in general, family firms are larger than non-family firms. The average
debt ratio stands at 1.45992 for non-family firms and 1.151114 for family firms, which
shows that, in general, family firms are less indebted than non-family firms and are
therefore less dependent on external funding.
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The family firms in our sample are not homogeneously divided among the countries
included and there are clear differences between them. For example, in South Korea, all
the companies analyzed in the period 2006-2010 were family firms. Among the other
countries with the highest percentage of family firms are France, Italy and Spain –
countries of western Europe with a strong concentration of ownership and voting rights
in the hands of families – and the USA. Among the countries that stand out as having a
lower presence of family firms are Austria, New Zealand and Singapore. Furthermore,
the more reputable companies are not homogeneously divided among the countries in
the sample and again there are clear differences between them. Among the analyzed
countries with more reputable companies (those including in the World=s most admired
companies ranking), those that stand out are the USA (with 83.46 per cent of the total),
the UK, Japan and Germany (Table II).

Non-family firm Family firm Reputation ⫽ 0 Reputation ⫽ 1

Relative Relative Relative Relative
Country Absolute (%) Absolute (%) Absolute (%) Absolute (%)

Australia 178 3.72 14 1.94 192 3.87 0 0

Austria 32 0.67 1 0.14 33 0.67 0 0
Belgium 46 0.96 11 1.53 57 1.15 0 0
Canada 219 4.58 50 6.94 265 5.35 4 0.74
Denmark 51 1.07 5 0.69 56 1.13 0 0
Finland 38 0.79 5 0.69 39 0.79 4 0.74
France 118 2.47 86 11.94 194 3.91 10 1.84
Germany 159 3.33 47 6.53 188 3.79 18 3.31
Hong Kong 194 4.06 35 4.86 229 4.62 0 0
Italy 76 1.59 32 4.44 106 2.14 2 0.37
Japan 1,045 21.86 44 6.11 1,066 21.51 23 4.23
The Netherlands 54 1.13 6 0.83 60 1.21 0 0
New Zealand 40 0.84 4 0.56 44 0.89 0 0
Singapore 154 3.22 4 0.56 156 3.15 2 0.37
South Korea 0 0 12 1.67 12 0.24 0 0
Spain 67 1.4 29 4.03 96 1.94 0 0 Table II.
Sweden 68 1.42 8 1.11 76 1.53 0 0 Descriptive statistics:
Switzerland 63 1.32 29 4.03 89 1.8 3 0.55 family firms and
UK 801 16.76 70 9.72 847 17.09 24 4.41 reputation per
USA 1,377 28.81 228 31.67 1,151 23.22 454 83.46 country
 ARJ Table IV summarizes the Pearson correlation coefficients of the main variables used in
29,4 this study. The coefficients between the different independent variables are not very
high, indicating that there are no multicollinearity problems that might confound the
estimation (Table III).

4.2 Results obtained by dependency models

468 In this section, the relationship between EM and corporate reputation, and the
moderating role of family control are analyzed. In Table IV, regressions are developed
using the logit methodology implemented using panel data. The principal result of
Table IV shows the effect of EM on corporate reputation obtained from Fortune
Magazine. In this table, EM is measured by accounting practices (AEM) and real
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practices (REM) as robust result.

Regarding AEM, our first finding shows the negative effect of an EM strategy on
reputation and image. In view of this association (EM has a coefficient of 0.725546 and
is significant at the 95 per cent confidence level), our results show that EM practices
have a negative effect on corporate reputation, which is consistent with previous
evidence provided by Fombrun et al. (2000) and Roychowdhury (2006), among others.
The market and other stakeholders negatively value managers who carry out
discretional practices for short-term personal gains against the interests of
shareholders, investors and non-financial stakeholders. These corporate practices cause
the loss of support from the affected stakeholders and increase their activism (Zahra
et al., 2005).
Regarding the effect of family control on reputation, our explanatory dummy
variable shows a positive link between the presence of family shareholders in ownership
structure and company image and reputation, with a coefficient of 0.5011335 (but not
significant). This effect contributes to the sparse literature, showing that family firms
enjoy better market valuations and a higher reputation. This is primarily because the
interest and concern of family firms in safeguarding and protecting their corporate
reputation and identity is higher than that of non-family firms (Kashmiri and Mahajan,

Variables 1 2 3 4 5 6 7

1. REPUTATION 1
2. AEM ⫺0.1214 1
3. FAMILY 0.0501 ⫺0.0255 1
4. SIZE 0.2177 ⫺0.4265 0.0918 1
5. DEBT 0.0018 ⫺0.0243 ⫺0.017 0.0446 1
6. WORKING_CAPITAL 0.1956 ⫺0.1049 0.0489 0.212 ⫺0.0162 1
7. R&DINTENSITY ⫺0.004 0.0072 0.0428 ⫺0.0267 0.0024 ⫺0.0092 1

Notes: REPUTATION is a dummy variable that represents whether the firm is one of the most
admired companies worldwide or not; AEM is a numerical variable that represents earning
management through discretionary accruals of company i for period t; FAMILY is a dummy variable
that takes the value 1 for family firms and 0 otherwise; SIZE represents the size of company and is
measured by the logarithm of its total assets; DEBT reflects the debt of company and is calculated as the
ratio of debt to equity; WORKING_CAPITAL represents operating liquidity and is measured as the
Table III. difference between current assets and current liabilities; R&DINTENSITY represents the ratio of R&D
Bivariate correlations expenditure to total sales
 Dependent variable: reputation
Consequences
EM REM of earnings
Explanatory variables dy/dx Standard error dy/dx Standard error management
EM ⫺0.725546** 0.3267139 ⫺0.5712758** 0.257188
FAMILY 0.5011335 0.5638998 0.8129775 0.523725
EM ⫻ FAMILY 0.6638082* 0.7416103 0.2667086* 0.5980903
SIZE 0.2820065*** 0.0837941 0.323108*** 0.0844015
469
DEBT 0.0036487 0.0091973 0.0022225 0.009797
WORKING_CAPITAL 0.0001359*** 0.0000519 0.0001694*** 0.0000523
R&DINTENSITY 0.0018564 0.0772407 0.0001726 0.0738752
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d2006 ⫺1.751897*** 0.2900755 ⫺1.767128*** 0.2890158

d2007 ⫺1.544191*** 0.292932 ⫺1.54303*** 0.291221
d2008 ⫺1.656934*** 0.2886718 ⫺1.611359*** 0.2866852
d2009 ⫺0.0084615*** 0.254391 0.026401*** 0.2523898
d2010 Omitted Omitted
_cons ⫺9.864816 0.795313 ⫺9.86446*** 0.7778806
lnsig2u 3.665033 0.0865903 3.540954 0.088586
sigma_u 6.249595 0.270577 5.873653 0.2601617
rho 0.9223122 0.0062044 0.9129427 0.0070407

Notes: * , ** and *** indicate significance at a level of10, 5 and 1% respectively; dy/dx represents the
regression coefficient by applying a logit model with marginal effects for panel data; REPUTATION is
a dummy variable that represents whether the firm is one of the most admired companies worldwide or
not; AEM is a numerical variable that represents earning management (accounting practices) of
company i for period t; REM is a numerical variable that represents earning management (real
practices) of company i for period t; FAMILY is a dummy variable that takes the value 1 for family firms
and 0 otherwise; REM ⫻ FAMILY represents those family firms that carry out earnings management
practices; SIZE represents the size of company and is measured by the logarithm of its total assets; Table IV.
DEBT reflects the debt of company and is calculated as the ratio of debt to equity; Impact of earnings
WORKING_CAPITAL represents operating liquidity and is measured as the difference between management on
current assets and current liabilities; R&DINTENSITY represents the ratio of R&D expenditure to total corporate reputation
sales in family firms

2010). This positive effect also supports Gibbons and Murphy’s (1991) proposition that
the orientation and concern in relation to reputation is positively related to the long-term
perspective (one of the characteristics of family firms).
With respect to the aim of this paper, showing the moderating role of the family firm
in the link EM–reputation, the interaction between EM and family control, AEM ⫻
FAMILY represents those family firms that carry out EM practices. Specifically, the
coefficient of this variable shows how the negative effect of EM on reputation is
moderated by the presence of family in the ownership structure at the 90 per cent
confidence level (⫺0725546 ⫹ 0.6638082 ⫽ ⫺0.0617378). This moderating effect can be
explained in relation to two aspects, the first of which is the negative association
between family control and EM practices. The results of this research are consistent
with the argument that family ownership can reduce the classic agency problem
between principal (owners) and agent (managers). The strong power in decision making
on the part of family shareholders generates an alignment effect between the family’s
and the managers’ interests, decreasing the risk of expropriation and thus the incentives
 ARJ to carry out EM practices (Chen, 2006; Fields et al., 2001). Second, family firms show
29,4 their interest in and concern for safeguarding and protecting their corporate reputation
and identity. Family members identify their reputation with survival, maintaining an
approach aimed at gaining social legitimacy and enhancing their reputation (Dyer and
Whetten, 2006).
With the aim of achieving robust results, we consider another kind of EM practice. In
470 this case, we use REM as a measure of these discretionary practices. We consider REM
practices measured by the sum of abnormal CFO, discretionary expenses and
production cost (following the model proposed by Zang, 2012). Our results show the
negative effect of an REM strategy on reputation and image. As with the previous
measure of EM, REM has a coefficient of ⫺0.5712758 and is significant at the 95 per cent
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confidence level. Those companies that promote EM practices have to solve the problem
of the loss of corporate image and reputation. With respect to the impact of family firm
status on reputation, its coefficient is positive but not significant (0.8129775). However,
it shows how companies with ownership highly concentrated in the hands of a family
enjoy a better reputation and corporate identity. Moreover, they are more concerned
about reputation, as they link it with company survival.
Finally, as we anticipated in H1, the coefficient of REM ⫻ FAMILY shows how the
negative effect of REM on reputation is moderated by the presence of family in
ownership structure at the 90 per cent confidence level (⫺0.5712758 ⫹ 0.2667086 ⫽
⫺0.3045672). For companies with ownership highly concentrated in the hands of family,
this negative effect of REM on reputation is moderated, which can be explained by the
lower tendency of these companies to manage their results and by the family concern for
and guidance in maintaining their reputation.
In view of these robust results, we cannot identify differences in the functioning of
EM practices. Several studies suggest that firms use the manipulation of real activities
as an alternative to AEM, assuming there is a negative correlation between the two
manipulative practices (Zang, 2012). Therefore, AEM and REM are substitutes for each
other and either one can be used as a measure of manipulative behavior (Kim et al., 2012).
Regarding the control variables, SIZE and WORKING_CAPITAL maintain their
effect on the two models and are the only significant variables. Both positively impact on
corporate reputation. Thus, larger and more profitable companies tend to be more
reputable and admirable and belong to the “World=s most admired companies ranking”.
The level of indebtedness and intensity in R&D are not statistically significant in our
models.

5. Conclusions
This paper addresses two related research questions. First, what are the consequences
of EM practices for corporate reputation? The significance of this is that such
discretionary behaviors affect investors, employees, customers and local communities,
and are eventually reflected in corporate reputation and hence the market value. Second,
what is the association between EM and corporate reputation in the sphere of family
firms?
Using panel data to eliminate unobservable heterogeneity and estimate our models
using logit methodology, our findings support the proposition that EM practices
generate a negative impact on corporate reputation, as these discretionary practices
have several negative consequences not only on financial and economic aspects but also
 on the perceptions of the market and stakeholders. Regarding the moderating role of Consequences
family control, the results show how the negative effect of EM on reputation is lower in of earnings
the case of concentrated ownership in the hands of family. First, the presence of family
owners lowers the classic agency problem between owners and managers, decreasing
management
the incentives to carry out EM practices. Second, family owners are more concerned to
protect and improve the firm’s reputation as a result of the relative importance that they
attach to it. Our results are robust for different EM measures. 471
This paper has some limitations. Due to the information available in the different
databases, the sample is restricted to specific countries, and there are differences in the
observations among them. The sample includes many observations for the USA and
the UK but very few for Switzerland and Belgium. In addition, the last year used for the
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analysis is 2010. These limitations could be overcome in future studies. Another

limitation is related to the definition of “family firm”. In this paper, a firm is considered
“family” when a member of the founding family has at least 10 per cent of the ownership.
This is the approach most commonly used, but there is no universal definition. Thus, the
results could be different using other approaches to defining family firms. Finally, in
future lines of research, it could be interesting to include other corporate characteristics,
such as the dual existence of an audit committee and CEO, as well as the existence of
other owners (banks, government, etc.). In addition, the different corporate governance
systems according to countries’ characteristics could also be considered. Another
limitation is that family firms can display different forms and approaches in different
institutional environments. For this, future research could corroborate our evidence
considering some institutional moderating factors, such as culture, governance and
legal systems, education, etc.

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Further reading
474 García, J.P., Puerto, I.R. and De La Torre Olvera, C. (2008), “Does family ownership impact
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Corresponding author
Jennifer Martínez-Ferrero can be contacted at: jenny_marfe@usal.es

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