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Abstract

This study provides evidence that Belgian firms affiliated to a business group (holding) manage their earnings more than stand-alone firms. Earnings management is especially more prevalent in fully owned group firms compared to group firms with minority shareholders. This evidence is consistent with the hypothesis that controlling shareholders face fewer constraints to manage earnings if opportunistic earnings management cannot adversely affect the value of minority shareholders and is inconsistent with the claim that group firms would engage in earnings management to hide controlling shareholders' self-serving transactions. On the incentive part, we find that group firms strategically manage earnings in response to tax incentives. More specifically, we show that signed discretionary accruals of group firms depend significantly more on the marginal tax rate status of the firm as compared to independent firms. Finally, we document that earnings management is particularly facilitated through intra-group transactions.

7. Conclusions

While there is an extensive literature on business groups features, very few studies have explicitly focused on earnings management in business groups. In the current study, we are among the first examining firm-level discretionary accruals management activities in non-financial business groups and test at the same time for the predominance of tax incentives versus minority interest expropriation as a key driver for the observed earnings management. For a sample of Belgian business groups (holdings), we find that group firms manage their earnings more than stand-alone firms. This is consistent with the idea that group firms have more tools and opportunities to manage earnings compared to stand-alone firms. Furthermore, we find that fully-owned group firms in particular manage their earnings more, which is consistent with the hypothesis that controlling shareholders face fewer constraints to manage earnings of a fully-owned subsidiary because opportunistic earnings management actions cannot adversely affect the value of any minority shareholders. The positive effect of full ownership on earnings management is, however, inconsistent with the idea that group firms would engage in earnings management to hide self-serving transactions (wealth expropriation) made by the controlling shareholders. On the incentive part, we find that group firms strategically manage earnings in response to tax incentives. More specifically, discretionary accruals of group firms depend significantly more on the marginal tax rate status of the firm as compared to independent firms. To the best of our knowledge, this study is also one of the first documenting the importance of intra-group accruals contributing to earnings management within business groups. As such, it provides direct evidence for other studies arguing that complex business structures have unique features to obfuscate financial reporting quality (Kim & Yi, 2006; Rego, 2003).