Managerial ability and real earnings management in family firms

• DOI: https://doi.org/10.1108/CG-02-2021-0083
• Published date: 29 July 2021
• Date: 29 July 2021
• Pages: 1475-1494
• Subject Matter: Strategy,Corporate governance
• Author: Adhitya Agri Putra,Nanda Fito Mela,Ferdy Putra

Managerial ability and real earnings

management in family f‌irms

Adhitya Agri Putra, Nanda Fito Mela and Ferdy Putra

Abstract

Purpose –This study aims to examine the effect of managerial ability on real earnings management

(hereafterREM) in family firms.

Design/methodology/approach –The sampleconsists of 864 firms-years listed in theIndonesian Stock

Exchange.REM is measured by abnormal activities. Managerialability is measured by data envelopment

analysis.Data analysis uses random-effect regressionanalysis.

Findings –Family firms reducethe possibility of higher ability managers to engage in REM. Compare to

non-family firms, higher ability managers in family firms are more likely to engage in REM to improve

futureearnings.

Research limitations/implications –This research only uses efficiency score data envelopment analysis to

measure managerial ability while the managerial ability is, by nature, multi-dimensional and unobservable. This

research also does not find the role of professional Chief Executive Officer (hereafter CEO) in the family firms in

REM behavior because does not consider the professional CEO motivation (e.g. compensation structure).

Practical implications –This research is expected to helpfamily firms formulate managers’selection

based on managerial ability. This research also is expected to help investors and creditors to put their

funds in the familyfirms with higher ability managers that reduce earningsinformation distortion.

Originality/value –To the best of the author’s knowledge, this research is the first research that

examinesthe managerial ability on REM in Indonesianfamily firms. This research alsocontributes to fil the

findingsgap in managerial ability and REM.

Keywords Family f‌irms, Real earnings management, Managerial ability

Paper type Research paper

1. Introduction

Managerial characteristics are an essential factor to determine the policy and strategy as

managers are the main actors to run and execute the business decisions. One of the

characteristics is managerial ability. Managerial ability refers to the skill, knowledge,

expertise and experienceto make an effective business decision (Kor, 2003).

One of the managers’ goals is to beat earnings targets as it is important to evaluate managers’

performance. Earnings management can be used as a strategy to achieve the goal. Earnings

management refers to managers’ policy to change the earnings number by using accounting

standard weaknesses (accruals earnings management) or by deviating the normal b usiness

activities (real earnings management, hereafter REM) (Roychowdhury, 2006). Opportunistic

managers tend to use REM than the accruals one as regulatory bodies and auditors are more

likely to focus on accruals earnings management (Alzeban, 2019) than the real one, especially

after the Sarbanes-Oxley Act implementation (Cohen et al.,2008;Roychowdhury, 2006). For

example, Owusu et al. (2020) find that managers tend to shift accruals earnings management to

REM especially when the auditors are males ones. Also, REM activities are increased when there

is lower corporate governance, such as weak internal control (Al-Haddad and Whittington, 2019;

Wali and Masmoudi, 2020) or ineffective parent firms’ monitoring (Li et al., 2021).

Adhitya Agri Putra, Nanda

Fito Mela and Ferdy Putra

are all based at Riau

University, Pekanbaru,

Indonesia.

Received 22 February 2021

Revised 11 April 2021

12 May 2021

Accepted 5 June 2021

DOI 10.1108/CG-02-2021-0083 VOL. 21 NO. 7 2021, pp. 1475-1494, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 1475

Previous studies find the positive effect of managerial ability-related attributes , such as experience,

expertise and education, on REM (Alhmood et al.,2020;Li et al., 2016;Qi et al.,2018). On the

other hand, Huang and Sun (2017) find that higher ability managers have less REM. Inconsistence

of previous findings comes from the point of view that, all else equal, all managers with di fferent

ability have the same pressure to beat the earnings target (Huang and Sun, 2017). It leads to a

similar possibility to improve earnings opportunistically (Suryani et al.,2018). Huang and Sun

(2017) explain that if the relationship between managerial ability and REM is still questionable, then

there is a chance that firms’ characteristics more likely determine REM behavior.

The family attribute in the firms is one of the unique firms’ characteristics in Indonesia that

refers to family firms. Family firms are the firms where the founders or their family are

involved in the board, executive or as the block-holders shareholders (Cheng, 2014).

PricewaterhouseCoopers (2014) reports that 95% of businesses in Indonesia are family

businesses. Susanto et al. (2007)also report that 90% of listed firms in the Indonesian Stock

Exchange are family firms.

In the context of REM behavior, family firms perform effective monitoring to prevent

managers act opportunistically. Family firms are more likely to have lower agency conflicts

of managers-shareholders. Effective monitoring comes from motivation by founder and

family to maintain their reputation to not engage in controversial behavior such as earnings

management (Santoso and Rakhman, 2013) as the business will be passed on to the next

generation of the foundingfamily (Alves and Gama, 2020;Andres, 2008;Tabor et al., 2018).

Family firms do not only give priority to financial return but also family existence (G

omez-

Mejı

´aet al.,2007

), so higher business performance (explicitperformance) comes in second

place after the good reputation of the family name (culture performance) (Hall and

Nordqvist, 2008;Tabor et al.,2018). Previous studies (Achleitner et al.,2014;Ghaleb et al.,

2020;Tian et al., 2018) find that familyfirms are less engaged in REM.

The characteristic of family firms could moderate if higher ability managers decide to

engage in REM. As REM originally comes from a conflict of managers-shareholders, family

monitoring is expected to mitigate the conflict and reduce the opportunistic behavior of

managers. Family involvement can use the higher ability of managers to improve earnings

without deviating any normal level of firm business instead of using the aggressive strategy

of REM that can reduce firmreputation.

While Achleitner et al. (2014),Ghaleb et al. (2020) and Tian et al. (2018) find that family

involvement reduces REM; Razzaque et al. (2016) and Eng et al. (2019) find that family

firms have a greater level of REMthan non-family ones. Suhardianto and Harymawan (2011)

suggest that the inconsistency of monitoring function on earnings management behavior

comes from the unclear motivation of earnings management if it is done by opportunistic

motivation or efficient contracting one. As family firms are more likely to promote a good

reputation (Hall and Nordqvist, 2008;Tabor et al., 2018), they will allow managers to

engage in REM only for efficient contracting. As an efficient contract, REM can signal better

future earnings, while an opportunistic one can destroy the firms’ economic value

(Simamora, 2019). In this case, higher ability managers who engage in REM are more likely

to improve future earnings in family firms than non-family ones. Huang and Sun (2017) find

that managerial ability improvesREM as a signal of future performance.

This research aims to examine the role of family firms to mitigate higher ability managers to

engage in REM. To the best of the author’s knowledge, this research is the first study that

examines the managerial ability toward REM in Indonesian family firms. This research also

contributes to fil the findings gap of managerial ability and REM. As ability attributes of

managerial can both increase (Alhmood et al.,2020;Li et al.,2016;Qi et al., 2018)and

decrease (Huang and Sun, 2017) REM activities, this research follows the suggestion by

Huang and Sun (2017) by considering the firms’ characteristics to determine higher ability

managers’ behavior which is the family rolein the firms.

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