Firm borrowing capacity, government ownership and real earnings management. Empirical evidence from a developing country

• Date: 30 August 2019
• DOI: https://doi.org/10.1108/IJPSM-01-2019-0029
• Published date: 30 August 2019
• Pages: 339-362
• Author: Mouna Ben Rejeb Attia
• Subject Matter: Public policy & environmental management

Firm borrowing capacity,

government ownership and real

earnings management

Empirical evidence from a developing country

Mouna Ben Rejeb Attia

Higher Institute of Accountancy and Entrepreneurial Administration,

Manouba University, Manouba, Tunisia

Abstract

Purpose –The purpose of this pap er is to examine borrowi ng capacity (BC) of go vernment-owned

firms and whether real earnings management (REM) activities moderate the sensitivity of firm BC to

government ownership .

Design/methodology/approach –A simultaneous equation analysis is applied to study 210 Tunisian

non-financial firms over the 2001–2014 period.

Findings –The empirical results provide substantial evidence indicating that government-owned firms have

higher BC and significant REM than other firms; the relationship between government ownership and firm

BC is partially moderated by REM activities.

Practical implications –The findings imply that the implicit credit guarantee of government is not

necessarily the unique determinant of firm BC and highlight the role of lenders in monitoring discretionary

real transactions in government-owned and protected firms. These implications should be taken in to account

by public sector policy makers. In particular, the findings predict that the current government accounting

reform in Tunisia on the basis of IPSAS will, probably, improve information quality, but it is still insufficient

to control real activities in public institutions.

Originality/value –This study extends a growin g research stream on the relationship betwee n BC and

government ownership by focusing on the mode rating effect of REM o n this relationship a nd by

considering the endo geneity issue. The findings provide evi dence that government-owned firms us e REM

practices to improve the ir BC. Examining these practices in develop ing countries provides an opportunity

to evaluate the efficiency of their public sector reforms and their effect on a firm’s performance and

financing decisions.

Keywords Real earnings management, Government ownership, Borrowing capacity

Paper type Research paper

1. Introduction

Financing decisions are important for companies to determine their investment activities,

innovation and employment capacities (OECD, 2006). In fact, an inadequate finance policy

reduces firm growth (Fowowe, 2017). According to the trade-off theory, firms decide about

their capital structure depending on financing access constraints, the remuneration and debt

cost (Leland, 1994). Firm borrowing capacity (BC) is defined by Cassar et al. (2015) as a

higher credit amount, a lower interest rate and lower contracting costs.

Information asymmetry in accessing financing is one of the most important determinants

of a firm’s financing as suggested by accounting and finance literature (García-Teruel et al.,

2014). More specifically, government-owned firms are characterized by their higher levels of

asymmetric information, which makes it difficult for them to determine their BC, to evaluate

their investment projects and monitor their opportunistic behavior (García-Teruel et al.,

2014). Furthermore, financing decisions, in those companies, can be affected by their social

goals; poor performance and political connections. Managers decide to increase firm equity

and to privatize it or to increase its leverage depending on their financial situation and

investment opportunities. Therefore, government ownership and its impact on BC represent

one of the most important issues for both research and practice.

Received 31 January 2019

Revised 2 July 2019

Accepted 18 July 2019

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/0951-3558.htm

Firm BC,

government

ownership

and REM

InternationalJournalof Public

SectorManagement

Vol.33 No. 2/3,2020

pp.339-362

©EmeraldPublishingLimited

0951-3558

DOI10.1108/IJPSM-01-2019-0029

339

A vast literature examines the importance of ownership identity to determine the firm’s

capital structure (Agrawal and Nagarajan, 2012) and debt cost (Borisova and Megginson,

2011). Most of these studies focused on developed economies and did not examine the

differences between privately owned firms and government-owned firms. Similarly,

other studies like those of Florackis et al. (2009) and Abramov et al. (2017) report that

ownership structure has an impact on firm performance because of agency conflicts.

However, fewer studies examined the impact of ownership structure on firm capital

structure through agency conflicts (Sun et al., 2016). On the whole, little is known about

the impact of government ownership on firm BC in developing countries, where

government ownership prevails.

The repercussion of government ownership on firm BC seems ambiguous. On the one

hand, state control may decrease debt and increase its cost if government ownership

decreases corporate governance efficiency due to political, social interests and excessive

employment (Shleifer and Vishny, 1994, 1998). More specifically, poor governance of

government-owned firms is, principally, attributed to the government motivations to reduce

unemployment and social pressures (Du and Boateng, 2015). On the other hand, state control

may increase access to debt and decrease its cost if it reduces firm risk or increase business

and tax advantages (Wang and Shailer, 2012). Specifically, credit institutions are more likely

to provide loans to government-owned firms because government ownership seems to offer

an implicit credit guarantee payment (Dong et al., 2016).

While previous empirical studies examined the impact of government shareholdings on

debt and its cost, they report mixed findings about this relationship and they do not clarify

its ambiguity. In particular, Charumilind et al. (2006) and Qian et al. (2009) show that

government-connected banks provided more long-term loans and needed less collateral than

privately owned banks. However, Firth et al. (2008) document that government ownership

negatively correlates with capital structure. Furthermore, Dong et al. (2016) conclude that

government ownership does not, automatically, lead to a greater access to loans. This

relationship seems to depend on firm-specific variables. As for debt cost, Borisova and

Megginson (2011) find that private ownership is positively associated with debt cost.

Similarly, Shailer and Wang (2015) and Sánchez-Ballesta and García-Meca (2011) report that

government ownership is associated with lower debt cost. By contrast, Borisova et al. (2015)

find that government ownership has a negative effect on debt cost just during a financial

crisis period. Otherwise, this relationship is positive.

Despite the mixed empirical results on the relationship between government ownership

and firm BC, little attention has been given to the factors determining this relationship.

Dong et al. (2016) conclude that measuring the net effect of government ownership on debt

financing is difficult. The fundamental result of this study is that leverage is significantly

higher for government-owned firms in a cross-section analysis and that this positive

relationship becomes weaker when unobservable differences across firms are controlled.

Managers’discretionary behavior is one of the unobservable firm-specific variables which

can be studied through earnings management practices. These practices are often used by

managers when they plan to bypass debt restrictions (DeAngelo et al., 1994).

The separation between company ownership and its management leads to conflicts

between managers and stockholders ( Jensen and Meckling, 1976). This may lead managers

to opt for opportunistic practices to enjoy access to financial sources. In the same framework

of analysis, poor governance mechanisms, in government-owned firms, reduce their

efficiency and intensify agency conflicts and information asymmetries (Vining and

Boardman, 1992). These factors motivate earnings management practices in

government-owned firms (Ding et al., 2007). In particular, Ben-Nasr et al. (2015) argue

that managers in government-owned firms have incentives to manipulate earnings in order

to hide firm resources for political purposes and to preserve their position in the firm.

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