Title: Joseph Fan, TJ Wong, and Tianyu Zhang
1Asset Specificity, Accounting Quality and Family
Succession
- Joseph Fan, TJ Wong, and Tianyu Zhang
2Broad Research Questions
- Using the sample of family succession of 3 Asian
economies (HK, Singapore and Taiwan), we test if
change in control across generations affect
accounting quality - Succession effect only
- We test if degree of control by family and/or
founder shapes its accounting quality - Interacting family control and succession effects
3Motivation
- Contrast with US firms that examine primarily
entrepreneurial firms, we look at Asian family
firms. - Prior research (Fan and Wong, 2002) finds that
control concentration of Asian firms is
associated with lower accounting quality
(earnings-return relation) - Succession compares before and after periods,
reduce endogeneity - This paper provides an possible explanation for
why family control is associated with accounting
quality -- asset specificity, which lies deeper
than ownership and agency conflicts
4Definition of Succession
- Succession as an event in which a controlling
owner/manager steps down from the top executive
(usually chairman in Asia) positions - It is anticipated that sometimes it will be
ambiguous about when a succession starts and
ends. Typically succession is a process that
takes time to complete - We track firms from 5 years before to 5 years
after their chairman turnovers. - The event window is set by data availability
5Succession and Accounting
61. Family firms and their accounting system
- Accounting The familys and/or founders control
in the company will lead to an insider access
accounting system that relies heavily on private
channels rather than external financial
reporting, increasing its accounting opacity to
the public. - Reduction in control leads to more external
access accounting system
72. Specific Assets and Accounting
- An important benefit of family ownership is to
protect and capitalize on specific assets or
non-transferable property rights (Alchian, 1965,
1969 Coase, 1937, 1960 Demsetz, 1964, 1967) - e.g. family reputation, a secret formula,
business network and political connections or
assets that generate amenity utilities - Specific assets are associated with opaque
accounting - Opacity helps to protection networks and
connection - Hard to account for specific assets and related
transactions e.g. reputation is not capitalized
and its impairment is not associated with drop in
earnings
82. Specific Assets and Accounting
- Many of these specific assets are not fully
transferable, not even to ones children - This disruption during family succession allows
us to examine if the reduction in asset
specificity is associated with increase in
accounting quality around succession - Succession --gt higher accounting quality
- Interaction Reduction in family / founder
control, further increase in accounting quality
93. Predecessors Entrenchment
- Founder or departing chairman tries to hang on to
power - Asset specificity can be highly correlated with
entrenchment (hard to separate) - Firm experiences poor performance prior to
succession and tries to cover up - Firm performance and accounting quality improves
after the succession
10Measuring Accounting Quality
- How to measure quality in literature?
- Accruals (unsigned discretionary accruals) Leuz
et al. - Timely loss recognition Bushman et al.
- Earnings-return relations Fan and Wong, 2002
11Discretionary Accruals Estimation
- Modified Jones Model with contemporaneous ROA
- Total Acc / TA 1/TA b1 (?Sales-?AR) / TA b2
PPE / TA e - NI Total Acc CF, so higher Total Acc, higher
NI - Residual e is the unexpected change in
accruals. Manipulated level - Unsigned discretionary accruals measure how much
firms smooth earnings
12Timely Loss Recognition
- NI / MV a b1 Ret b2 RD b3 Ret x RD e
- Ret, net-of-market annual stock returns, proxies
for economic earnings - RD, dummy 1 when Ret lt 0, 0 otherwise
- Firms typical report bad news promptly, not good
news (conditional conservatism), b3 gt 0 - For firms that are opaque (insider access
system), b3 is less positive. - Insider system and less TLR
- Bushman et al., countries with more SOEs tend to
have less TLR - Ball et al. find that firms in code law countries
have less TLR
13Table 1 Sample
14Table 1 Sample
15Accounting quality before and after
successionQuestion 1 We expect lower quality
before and higher quality after
16Table 3 Level of discretionary accruals--Univaria
te analysis
17Table 3 Level of discretionary accruals--multivar
iate analysis
18Table 4 Timely loss recognitionPanel A
Descriptive statistics
19Table 4 Timely loss recognitionPanel B
Succession v.s. non-succession
20Table 4 Timely loss recognitionPanel C Before
v.s. after succession
21Table 5 Earnings persistence
22Family/Founder control and accounting
qualityQuestion 2 Family/founder control is
associated bigger change in Discretionary
Accruals and TLR before and after succession
23Proxies for Family/Founder Control
- Control concentration
- Family ownership concentration
- Voting and control rights divergence
- Board control prior to succession
- Family control of board
- Founder as predecessor
- Family control after succession
- Departing chairmen remains in management
- Heir successor
- Regulated and amenity industries (asset
specificity)
24Table 6 Change is DA
25Table 7 Change in TLR
26Asset specificity and accounting qualityTLR
and Discretionary Accruals prior to succession
27Table 8 Discretionary accruals prior to succession
28Table 9 TLR prior to succession
29Need further analysis
- Entrenchment? Predecessor holding on to power,
thus opaque accounting. - Low accounting quality prior to succession. No
difference after succession. - Passing control to heir successor or chairman
hangs on to power, there is improvement in
accounting but mainly due to poorer accounting
prior to succession and not superior accounting
after succession. - However, no significant drop in earnings prior to
succession. Also there is no earnings management
or shifting.
30Further analysis
- Asset specificity
- There is significant drop in stock returns but no
significant drop in earnings - We dont find significantly positive
discretionary accruals prior to succession
(earnings management to sustain positive
earnings) - There is also lower TLR prior to succession, and
the TLR is lower for firms with more family
and/or founder control prior to succession and
those that pass the control to an heir. - What explains the drop in share value?
- Specific assets are more like unrecognized
goodwill. Their impairment will be reflected in
the share value but not in earnings. - At the succession, there is a dissipation in
value of the specific assets, which is reflected
in the negative stock returns but there is little
drop in short term earnings.
31Conclusion
- Succession affects accounting quality
- Family control and asset specificity measures
matter. - Need to know more about combination of asset
specificity, way of transfer of control and
accounting properties
32Future Directions
- Entrepreneurial firms are becoming important in
China - China now has about 300 firms ultimately
controlled by an non-state entity - These firms, when cross-listed in HK, have many
accounting scandals. Why? - What shapes their governance structure and
financial reporting incentives? - How can their governance and accounting be
improved in the future?