Journal of Family Business Strategy 4 (2013) 8492

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Journal of Family Business Strategy

journal homepage: www.elsevier.com/locate/jfbs

The conditional nature of board characteristics in constraining earnings

management in private family rms
Annelies Stockmans 1, Nadine Lybaert 2, Wim Voordeckers *
Hasselt University, KIZOK Research Center, Martelarenlaan 42, 3500 Hasselt, Belgium

A R T I C L E I N F O A B S T R A C T

Article history: The goal of this article is to examine the inuence of the board of directors in constraining earnings
Received 14 June 2011 management in private family rms. We build further on the premise that corporate governance is
Received in revised form 21 December 2012 conditional in nature. Specically, we propose that the effect of the proportion of outside directors and
Accepted 31 January 2013
CEO duality on earnings management is stronger when the family rm faces signicant agency
problems. Our results nd support for the fact that, conditional on the presence of agency conicts
Keywords: between controlling and noncontrolling shareholders, a higher proportion of outside directors and CEO
Earnings management
nonduality may have a constraining effect on earnings management. This is in support of our argument
Outside directors
CEO duality
that the relationship between board characteristics and earnings management is moderated by the
Private family rms potential presence of agency conicts.
2013 Elsevier Ltd. All rights reserved.

1. Introduction management behavior. Indeed, earnings management can be used

Accounting practices in family rms have received relatively
little attention when compared to their publicly held counterparts
(Salvato & Moores, 2010). Only recently, research at the intersec-
tion of accounting and family rms has attracted the attention of
both accounting and family rm scholars (e.g., Niskanen,
Karjalainen, & Niskanen, 2010; Setia-Atmaja, Tanewski, & Skully,
2009; Trotman & Trotman, 2010). The earnings management
behavior of family rms and the effect of family ownership on
nancial reporting quality in general, have been topics of great
interest within this stream of research (e.g., Ali, Chen, &
Radhakrishnan, 2007; Cascino, Pugliese, Mussolino, & Sansone,
2010; Jaggi, Leung, & Gul, 2009; Jiraporn & DaDalt, 2009; Prencipe,
Bar-Yosef, Mazzola, & Pozza, 2011; Prencipe, Markarian, & Pozza,
2008; Stockmans, Lybaert, & Voordeckers, 2010; Tong, 2007;
Wang, 2006; Yang, 2010).
Throughout the years, a vast amount of research in accounting
literature has found evidence for a mitigating effect of the board of
directors on agency problems (e.g., Beasley, 1996; Benkel, Mather,
& Ramsay, 2006; Dechow, Sloan, & Sweeney, 1996; Peasnell, Pope,
& Young, 2005), such as for example reected in earnings
* Corresponding author. Tel.: +32 11 268613; fax: +32 11 268700.
E-mail addresses: annelies.stockmans@uhasselt.be (A. Stockmans), nadine.ly-
baert@uhasselt.be (N. Lybaert), wim.voordeckers@uhasselt.be (W. Voordeckers).
1
Tel.: +32 11 268070; fax: +32 11 268700.
2
Tel.: +32 11 268602; fax: +32 11 268700.
by organizational decision-makers to facilitate or maximize the
pursuance of the own interests or to justify or hide the
performance effects of opportunistic behavior (Ali et al., 2007).
A board of directors is then considered as a key constraining
mechanism on these kinds of agency problems. In the context of
family rms, however, the evidence of the impact of board
characteristics on agency problems (and as a consequence on the
level of earnings management) is scant. For example, based on the
argument that board member independence is lower in family
rms and therefore the risk of collusion with the dominant family
is high, it is found that the impact of outside directors and CEO
nonduality on earnings management is weaker for public family
rms than for public nonfamily rms (Jaggi et al., 2009; Prencipe &
Bar-Yosef, 2011). These ndings indicate that the board of directors
is less effective in performing its monitoring role in family rms
than in nonfamily rms. Yet, other studies found that independent
directors have a more substantial role in mitigating agency
conicts in family rms than in nonfamily rms (Anderson & Reeb,
2004).
However, governance literature has shown that the relationship
between board characteristics and performance is moderated by
the potential presence of agency conicts indicating that the
monitoring role of the board is conditional in nature (Chi & Lee,
2010; Perry & Peyer, 2005). So a possible explanation for the
discrepancy on the effectiveness of the board in performing its
control task in family rms is that prior research on earnings
management in family rms has not taken this conditional aspect
into account. By not controlling for the conditional nature of the

1877-8585/$ see front matter 2013 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.jfbs.2013.01.001
 A. Stockmans et al. / Journal of Family Business Strategy 4 (2013) 8492
inuence of board characteristics, these studies are by construction
low-power tests and therefore they might fail to detect a
signicant relation between board characteristics and earnings
management. The aim of this study is, therefore, to advance the
understanding of the role and contribution of outside directors and
the separation of CEO and board chair roles in constraining
earnings management in family rms by examining the condi-
tional nature of the board of directors. More concrete, since prior
earnings management research has identied the agency problem
between controlling and noncontrolling shareholders as a driver of
family rms earnings management behavior (Ali et al., 2007; Jaggi
et al., 2009; Prencipe & Bar-Yosef, 2011; Tong, 2007; Wang, 2006),
this article examines the relationship between board character-
istics and earnings management conditional on (moderated by) the
presence of agency problems between controlling and noncon-
trolling shareholders the family rm faces.
To test the conditional nature of corporate governance in family
rms we use a sample of private family rms. Although family
rms are especially prevalent among privately held SMEs
(Corbetta & Montemerlo, 1999; Daily & Dollinger, 1993; Donckels
& Frohlich, 1991) and international evidence suggests that
earnings management is more prominent in private rms than
in public rms (Burghstahler, Hail, & Leuz, 2006), few empirical
studies on earnings management in family rms are conducted
within the setting of privately held family rms. Therefore, private
family rms provide an important setting to investigate the
conditional nature of board characteristics in constraining
earnings management.
By examining the impact of outside directors and CEO duality
on earnings management conditional on the presence of agency
problems in a private family rm setting, we contribute to the
literature in several ways. First, up till now studies examining the
corporate disclosure quality and earnings management behavior of
family rms mainly aimed at identifying differences between
public family and nonfamily rms. Ali et al. (2007), for example,
show that, compared to nonfamily rms, family rms report better
quality earnings and are more likely to warn for a given magnitude
of bad news. Jiraporn and DaDalt (2009) nd that family rms have
lower discretionary accruals than nonfamily rms. Wang (2006)
shows that founding family ownership is associated with lower
abnormal accruals, greater earnings informativeness and less
persistence of transitory loss components in earnings. Current
research, however, acknowledges the heterogeneity within family
rms and focuses on differences in earnings management behavior
depending on the type of family rm (e.g., Stockmans et al., 2010;
Yang, 2010). By simultaneously examining the role of board
characteristics and agency problems in inuencing earnings
management behavior within a sample of private family rms,
thereby exploring differences among private family rms, we aim
to add to this stream of research.
Second, while agency theory suggests that the marginal value of
governance increases with the potential severity of agency
problems (Jensen, 1986), studies examining the relation between
governance and corporate outcomes typically do not control for
differences in agency problems across rms. Only recently, studies
started to acknowledge the conditional nature of the value of
corporate governance, i.e. corporate governance only inuences
performance if agency problems are present (e.g., Chi & Lee, 2010).
This article contributes to this emerging stream of research by
providing evidence for the conditional nature of the inuence of
board characteristics in a family rm setting.
Third, by focusing on a sample of private family rms our study
adds to the empirical evidence on the role of the board of directors
in an important yet under-researched segment of rms. Finally, by
examining the role of board leadership structure and
the proportion of outside directors in constraining earnings
85
management, this article contributes to the scarce research on
the boards monitoring role in family rms. While prior research
emphasized the advice role of outside directors in family rms,
scant evidence in the context of private family rms shows that the
monitoring role may be important as well (Bammens, Voordeckers,
& Van Gils, 2008; Van den Heuvel, Van Gils, & Voordeckers, 2006).
The remainder of this article proceeds as follows. Section 2
discusses related literature and presents the hypotheses that will
be examined. Section 3 describes the data and the empirical
method used to test the hypotheses. Section 4 presents the results.
Finally, Section 5 discusses our ndings, presents a conclusion and
addresses practical implications and implications for future
research.
2. Literature review and hypotheses
2.1. Board composition and earnings management
The link between board characteristics and earnings manage-
ment is grounded in the agency view of corporate governance. At
the core of this view is the risk that organizational decision-makers
may behave opportunistically by pursuing their own interests or
spending insufcient effort toward achieving agreed-upon rm
objectives (Bammens, Voordeckers, & Van Gils, 2011; Fama &
Jensen, 1983; Jensen & Meckling, 1976). According to traditional
agency theorists the installment of a board of directors is an
efcient instrument to control these organizational decision-
makers and therefore to reduce agency costs (Fama & Jensen,
1983). In general terms, the boards control task thus refers to the
legal duty the board has to monitor organizational decision-
makers for the benet of the corporation (Forbes & Milliken, 1999;
Johnson, Ellstrand, & Daily, 1996). This control task comprises a
whole range of responsibilities including monitoring the quality of
information contained in nancial reports (Beasley, 1996; Vafeas,
2000). The necessity to monitor the quality of nancial reports
stems from the discretion organizational decision-makers have in
reporting earnings. Due to incomplete contracts and information
asymmetry between organizational decision-makers and other
parties, organizational decision-makers can use this discretion to
promote their own interest (Eisenhardt, 1989; Jensen & Meckling,
1976). Hence, earnings management is used to facilitate or
maximize the pursuance of their own interests or to justify or
hide the performance effects of their opportunistic behavior (Ali
et al., 2007). Thus, the more effective boards can perform their
control task, the more likely it is that earnings management
behavior is revealed and coped with and consequently the more
likely it is that the information included in nancial reports reects
reality.
Accounting literature has identied factors inuencing the
boards effectiveness in performing its control task and has shown
that a higher proportion of outside directors and CEO nonduality in
particular improve and facilitate the monitoring and control
exerted by the board (e.g., Beasley, 1996; Benkel et al., 2006;
Dechow et al., 1996; Peasnell et al., 2005). From a traditional
agency perspective, boards should be able to act independent of
those parties whom they are supposed to control and therefore
boards must be dominated by independent directors (Benkel et al.,
2006; Van den Berghe & Levrau, 2004). Although outside directors
are not necessarily the most independent directors, outsiderness is
an indicator of independence commonly used by prior research
(e.g., Fiegener, Brown, Dreux Iv, & Dennis, 2000a, 2000b; Jaskiewicz
& Klein, 2007). Hence, it is assumed that the higher the proportion
of outside directors, the more independent the board is and
consequently the more effective the board is in completing its
control task. A vast amount of accounting literature has conrmed
that a higher proportion of outside directors leads to reduced levels
86 A. Stockmans et al. / Journal of Family Business Strategy 4 (2013) 8492
of earnings management (e.g., Dechow et al., 1996; Klein, 2002;
Osma & Noguer, 2007; Peasnell, Pope, & Young, 2000; Peasnell
et al., 2005).
CEO duality, or whether the CEO is also vested with the title of
chairman of the board, is considered to be an indicator of the CEOs
power and his/her ability to control the board (Ronen & Yaari,
2008). The CEOs power to control the board when acting as the
chair of the board comes from the fact that the chair is responsible
for setting the agenda and running board meetings and from the
importance of the boards role in appointing and monitoring
organizational decision-makers (Chtourou, Bedard, & Courteau,
2001). Hence, several researchers have argued that when the CEO
serves as the chairman of the board, a boards independence
reduces making the board less effective in performing its control
task (e.g., Fama & Jensen, 1983; Jensen, 1993). Earnings manage-
ment research has shown that CEO duality can be associated with
a higher level of earnings management supporting the argument
that board monitoring is less effective in rms that combine the
positions of CEO and chairman (e.g., Cornett, Marcus, & Tehranian,
2008; Dechow et al., 1996; Mather & Ramsay, 2006).
2.2. Outside directors, CEO duality and earnings management in
family rms
Although a vast amount of accounting literature has shown that
a higher proportion of outside directors and the separation of CEO
and board chair roles limit earnings management (e.g., Benkel
et al., 2006; Cornett et al., 2008; Dechow et al., 1996; Klein, 2002;
Mather & Ramsay, 2006; Peasnell et al., 2005; Vafeas, 2005; Van
den Berghe & Levrau, 2004), there is little empirical evidence on
this matter in the context of family rms. Moreover, the scant
research that has examined this issue has focused on comparing
family and nonfamily rms.
Based on the argument that board member independence is
lower in family rms and therefore the risk of collusion with the
dominant family is high, prior research has, for example, shown
that the constraining effect of outside directors on earnings
management is weaker for public family rms than for public
nonfamily rms (Jaggi et al., 2009; Prencipe & Bar-Yosef, 2011).
This supports the idea that outside directors are included in the
board for their advice role rather than for their control role. Van
den Heuvel et al. (2006), however, argue that while the advice role
of the board is perceived to be the most important board role, the
control role is also a major board role. Moreover, Bammens et al.
(2008) show that, although outside directors are mostly included
for their advice role in private family rms, once on the board these
outsiders also take care of their legal monitoring duties. These
studies, therefore, suggest that the inclusion of outside directors in
private family rms boards should also be valuable in constraining
earnings management.
With regard to the inuence of CEO duality on earnings
management in family rms, Braun and Sharma (2007) argue that
separating CEO and board chair roles in family rms ensures that
the decision-making process is not dominated by the controlling
family shareholders neglecting the interests of minority share-
holders. Consistent with the traditional agency perspective on
corporate governance, their results support the fact that, in
family rms, the separation of CEO and board chair roles is
effective in controlling agency problems between controlling
family and noncontrolling shareholders. Prencipe and Bar-Yosef
(2011) report similar results, although they found that CEO
nonduality has a weaker effect on the magnitude of earnings
management in family-controlled than in nonfamily-controlled
companies.
In sum, based on these prior ndings, we propose the following
two hypotheses:
Hypothesis 1a. There is a negative relationship between the pro-
portion of outside directors and the level of earnings management
in private family rms.
Hypothesis 1b. There is a positive relationship between CEO du-
ality and the level of earnings management in private family rms.
2.3. The conditional nature of corporate governance in family rms
As the previous subsection summarizes, family rm researchers
have not reached consensus on the importance of the boards
control role and therefore on the inuence of board characteristics
on the level of earnings management. A possible explanation for
this inconsistency is that empirical research on this matter has
thus far focused on identifying differences between family and
nonfamily rms thereby considering family rms to be one
homogeneous group of rms. Yet, recent studies have acknowl-
edged that family rms are a heterogeneous group (Corbetta &
Salvato, 2004b; Sharma, 2004; Westhead & Howorth, 2007). In
addition, while agency theory suggests that governance matters
more among rms with greater potential agency costs, prior
empirical research has not controlled for the severity of agency
problems (Chi & Lee, 2010; Jensen, 1986). In this article we,
therefore, extend traditional research by examining the role of
outside directors and the absence of CEO duality in constraining
earnings management while differentiating between different
types of family rms based on the agency conicts they face.
Traditional agency theory considers family rms to be a low or
even zero agency cost case (Ang, Cole, & Lin, 2000; Jensen &
Meckling, 1976). Yet, while in family rms the ownermanager
agency problem might be less prevalent, agency problems between
controlling family shareholders and noncontrolling shareholders
can arise (Villalonga & Amit, 2006). Due to the family shareholders
concentrated ownership, their voting rights exceeding their cash
ow rights and the familys domination over the board of directors,
family shareholders can exercise substantial control over the rm.
This control gives family shareholders the power to seek private
benets at the expense of (nonfamily) minority shareholders. In
order to maximize, justify or hide the extraction of these private
benets, controlling family shareholders have incentive to manage
earnings (Ali et al., 2007). Prior research examining earnings
management in the context of family rms has therefore focused
on the agency problem between controlling and noncontrolling
shareholders as an explanation for earnings management behavior
and low nancial reporting quality in family rms (e.g., Ali et al.,
2007; Prencipe & Bar-Yosef, 2011; Tong, 2007). Based on the
argument that a governance mechanism only matters when
agency problems arise, we expect that a higher proportion of
outside directors and the separation of CEO and board chair roles
will only be valuable in constraining earnings management in
family rms facing agency problems between controlling and
noncontrolling shareholders. Hence, we present the following
hypotheses:
Hypothesis 2a. The expected negative relationship between the
proportion of outside directors and the level of earnings manage-
ment is moderated by the presence of agency problems between
controlling and noncontrolling shareholders. That is, the relation-
ship between the proportion of outside directors and the level of
earnings management is stronger for family rms facing agency
problems due to the conict between controlling and noncontrol-
ling shareholders.
Hypothesis 2b. The expected positive relationship between CEO
duality and the level of earnings management is moderated by the
presence of agency problems between controlling and
 A. Stockmans et al. / Journal of Family Business Strategy 4 (2013) 8492
noncontrolling shareholders. That is, the relationship between CEO
duality and the level of earnings management is stronger for family
rms facing agency problems due to the conict between control-
ling and noncontrolling shareholders.
A graphical representation of our model can be found in Fig. 1.
3. Method
3.1. Data
The empirical data on the family rm characteristics used to
test the hypotheses presented are derived from a wider survey
exploring the general characteristics as well as management
issues, board composition, governance, family features and
succession of Belgian family businesses. This survey was mailed
to the CEOs of 3400 rms which were randomly selected from a
family-business database. The time frame of the data collection
was 2003. All rms in the sample were privately owned and
employed at least ve people. To dene family rms, the paper
applies a commonly used denition of family rms (e.g., Van den
Heuvel et al., 2006; Voordeckers, Van Gils, & Van den Heuvel, 2007)
based on the criteria of ownership, management and control (Chua,
Chrisman, & Sharma, 1999) and the CEOs perception about the
rm being a family rm (Westhead & Cowling, 1998). Hence the
sampled rms were categorized as family rms if they t to one of
the following descriptions: (1) at least 50% of the shares are owned
by family members and the family is responsible for the
management of the business, (2) at least 50% of the shares are
owned by family members, the company is not family managed
but the CEO perceives the rm as a family business, (3) family
ownership is less than 50%, the company is family managed, the
CEO perceives the rm as a family rm and a venture capital or
investment company owns at least 50% of the shares. Of 311
returned surveys, 295 contained sufcient data to be included in
the database. We examined the nonresponse by testing for
statistical signicant differences on several key characteristics of
the sample (size, age, board size, independent directors). We only
found that the average board size and the proportion of outside
directors were slightly higher in the sample (although not
statistical signicant) which suggests that the sample contains
more active boards than the population.
Financial data on these rms were retrieved from BEL-FIRST, a
nancial database supplied by Bureau Van Dijk. Since in Belgium
rms meeting certain size criteria are allowed to publish their
nancial reports using an abbreviated scheme, some of the private
family rms did not provide the nancial data needed for the
estimation of the amount of discretionary accruals (our measure of
earnings management) such as for example the sales gure.
Agency problems between
controlling and
noncontrolling shareholders
Board characteristics
H2a H2b
Proportion of
outside directors - The level of earnings
H1a
management
CEO + dummy variable is used with a value 1 if 100% of the shares is held
duality
H1b
Fig. 1. Theoretical model.
87
Therefore, we included only the rms in the nal sample that
reported their nancial statements using a full scheme. After
eliminating missing values (especially due to the abbreviated
scheme) and removing outliers, a nal sample of 79 remained. Due
to this smaller sample size and the lower power this entails, our
results have to be interpreted as exploratory in nature.
3.2. Variables
3.2.1. Dependent variable
We use the amount of discretionary (abnormal) accruals as a
proxy for the extent of earnings management. Consistent with
prior research (e.g., DeFond & Park, 1997; Kothari, Leone, & Wasley,
2005; Subramanyam, 1996), we compute the amount of discre-
tionary accruals (DAs) by estimating the modied Jones model
cross-sectionally (per two-digit NACE-BEL group; NACE-BEL is a
Belgian industry classication system similar to US SIC) for the
year 2003. Because of our relatively limited sample size, an out-of-
sample estimation approach is used to estimate parameter
estimates. Following Teoh, Welch, and Wong (1998) and Beneish
(1998), we focus on current accruals instead of on total accruals
because the long-term component incorporated in total accruals
provides limited potential as a tool for systematic earnings
management. In addition, following Kothari et al. (2005), we
include a constant in our model because this has many advantages;
for example, it provides an additional control for heteroscedas-
ticity not alleviated by using assets as the deator and mitigates
problems stemming from an omitted size variable. Hence, in our
study DAs are dened as follows:
"   #
DAt CAt 1 b DREVt  DRECt
 b0 b1 2
At1 At1 At1 At1
where CAt is current accruals in year t (dened as the change in
current assets during period t minus the change in current liabilities
during period t minus the change in cash and cash equivalents
during period t plus the current maturities of long-term debt and
other short-term debt included in current liabilities during period t),
At1 is total assets at the end of year t  1, DREVt is revenues in year t
less revenues in year t  1, and DRECt is receivables in year t less
receivables in year t  1. Finally, since the goal of our article is to
analyze earnings management in general rather than to focus on
income-increasing or income-decreasing earnings management, we
use the absolute value of the discretionary accruals in our tests.
3.2.2. Independent variables
To determine the proportion of outside directors, the survey
included a question in which respondents were asked to indicate
the number of outside directors. By dividing this number by the
total number of board members, we attain the proportion of
outside directors. CEO duality is measured by a binary variable
with a value of 1 if the CEO serves as the chairman of the board and
0 otherwise.
Our moderator is the presence of agency problems between
controlling and noncontrolling shareholders. If ownership is not
fully vested into the hands of the family but instead it is divided
among the controlling family and a group of minority shareholders,
agency problems between controlling and noncontrolling share-
holders arise. Therefore, to proxy for the presence of agency
problems between controlling and noncontrolling shareholders a
by the controlling family and 0 otherwise.
We also include proxies for other factors that might affect the
level of earnings management in the regression model. Leverage
(total debt divided by total assets) is included to control for the
debt covenant hypothesis (Smith, 1993; Watts & Zimmerman,
88 A. Stockmans et al. / Journal of Family Business Strategy 4 (2013) 8492

Table 1
Descriptive statistics.

Variable Mean Std dev. N Abs(discretionary Proportion CEO 100% family Leverage Firm age Sales Cash from
accruals) of outside duality ownership growth operations
directors

Abs(discretionary accruals) 0.07 0.06 1.00

Proportion of 0.08 0.17 0.02 1.00
outside directors
CEO duality (1/0) 70.88% 0.10 0.32** 1.00
100% family ownership (1/0) 88.61% 0.03 0.28* 0.03 1.00
Leverage 0.60 0.22 0.03 0.02 0.00 0.08 1.00
Firm age 41.26 29.11 0.13 0.11 0.25* 0.07 0.17 1.00
Sales growth 0.04 0.19 0.07 0.18 0.20y 0.03 0.01 0.11 1.00
Cash from Operations 0.06 0.11 0.47*** 0.04 0.05 0.04 0.18 0.07 0.02 1.00
y
p < 0.10.
*
p < 0.05.
**
p < 0.01.
***
p < 0.001.

1978). The debt covenant hypothesis states that after debt
contracts have been negotiated, rms have incentive to make
income-increasing accounting choices to avoid the violation of
covenants in their debt agreements (Beneish & Press, 1993).
Furthermore, rm age (rm age in years) and sales growth
(revenues at the end of year t less revenues at the beginning of year
t scaled by revenues at the beginning of year t) are included as
variables to control for the political cost hypothesis. The political
cost hypothesis states that the greater the political costs for the
rm (e.g., taxes or costs incurred by governmental or industry
regulations), the more incentive managers have to make income-
decreasing accounting choices to reduce the size or the likelihood
of politically imposed wealth transfers (e.g., Adhikari, Derashid, &
Zhang, 2005; Watts & Zimmerman, 1978). Finally, we also include
cash ow from operations (CFO) (Dee, Lulseged, & Nowlin, 2006).
3.3. Descriptive statistics
Table 1 presents descriptive statistics on the variables included
in our study. The mean family rm performing earnings
management reports DAs that are 6.9% of lagged total assets.
The mean family rm is 41.26 years old and has a yearly sales loss
of 3.6%. Table 1 also shows that the mean family rm has a leverage
ratio of 60%, and cash ow from operations that is 5.9% of lagged
total assets. In addition, the mean family rm has a board with 7.9%
outside directors and most (70.88%) of the rms in our sample have
CEO duality. Finally, 88.61% of the rms in our sample is 100%
family-owned.
4. Results
Results of the ordinary least squares regressions that corre-
spond to the hypotheses presented in this article are reported in
Table 2. The White test indicates no presence of heteroscedasticity
problems, and because all variance ination factors fall below the
cutoff point of 10 (highest mean VIF 3.87), multicollinearity is not a
problem (Kennedy, 2008). Column 1 of Table 2 shows the result of
the regression examining the inuence of the proportion of outside
directors on earnings management, whereas column 2 of Table 2
shows the result of the regression examining the inuence of CEO
duality. These results show no signicant direct effect of the
governance characteristics on the level of earnings management in
private family rms. Hence, these ndings do not support
Hypotheses 1a and 1b. The fact that both hypotheses are not
supported is in line with the results found by Prencipe and Bar-
Yosef (2011) who nd that the impact of board independence and
the lack of CEO-board chairman duality on earnings management
is weaker in family rms than in nonfamily rms. In addition, the
insignicant results are consistent with our key argument that
corporate governance in private family rms is conditional on the
presence of potential agency problems between controlling and
noncontrolling shareholders. Hence, it may be not a surprise that
neglecting to take into account this moderating agency condition
delivers insignicant direct effects between our corporate gover-
nance variables and earnings management.
Column 3 of Table 2 shows the result of the regression
examining the conditional inuence of the proportion of outside
directors on earnings management. The result shows that a higher
proportion of outside directors leads to a reduction in earnings
management of by average 15% (p < 0.05) of lagged total assets for
family rms where the family does not hold 100% of the shares. In
family rms where ownership is fully concentrated in the hands of
the family (100% family ownership) a higher proportion of outside
directors only has a weak positive (5.90% of lagged total assets)3
but signicant (p < 0.05) effect on the level of earnings manage-
ment. These ndings support Hypothesis 2a. Column 4 of Table 2
shows the result of the regression examining the conditional
inuence of CEO duality on earnings management. This result
shows that in rms with 100% family ownership, CEO duality only
has a weak negative (2.30% of lagged total assets)4 but signicant
(p < 0.05) effect on the level of earnings management. Moreover,
although not signicant (p = 0.109), the result of CEO duality gives
us an indication that in family rms where the family does not hold
100% of the shares CEO duality leads to earnings that are by
average 5.09% of lagged total assets larger than in rms without
CEO duality. Hence, from these ndings we infer some weak
support for Hypothesis 2b.
To facilitate the interpretation of the coefcients of the
interaction effects, we plot the results of our regressions in
Figs. 2 and 3 as is suggested by Aiken and West (1991) and Cohen
and Cohen (1993). In Fig. 2 the full line represents the effect of the
proportion of outside directors on earnings management when
ownership is not 100% concentrated in the hands of the family. The
dotted line indicates the effect of the proportion of outside
directors on earnings management when there is a 100% family
ownership. The graph clearly shows that the full line is steeper
than the dotted one which implies that the effect of the proportion
of outside directors on earnings management is stronger when the
rm is not 100% family owned and thus faces agency problems due
to the conict between controlling and noncontrolling share-
holders. Hence, Hypothesis 2a is supported. In line with prior
3
5.90% = (0.153 + 0.212)  100.
4
2.30% = (0.0510.074)  100.
 A. Stockmans et al. / Journal of Family Business Strategy 4 (2013) 8492 89

Table 2
Results of OLS regressions.

Variable Abs(discretionary accruals) (N = 79)

(1) (2) (3) (4)

Control variables
Leverage 0.009 (0.029) 0.008 (0.028) 0.004 (0.028) 0.007 (0.028)
Firm age 0.000 (0.000) 0.000 (0.000) 0.000* (0.000) 0.000* (0.000)
Sales growth 0.027 (0.025) 0.023 (0.024) 0.038 (0.024) 0.020 (0.025)
Cash from operations 0.279*** (0.075) 0.270*** (0.073) 0.260*** (0.074) 0.258*** (0.072)
Board characteristics
Proportion of outside directors 0.022 (0.043) 0.153** (0.075)
Proportion of outside directors  100% family ownership 0.212** (0.089)
CEO duality 0.020 (0.019) 0.051 (0.031)
CEO duality  100% family ownership 0.074** (0.036)
100% family ownership 0.040 (0.031) 0.046* (0.023)
R2adjusted 0.249 0.261 0.295 0.282
F statistic 3.39*** 3.06** 3.77*** 2.81**

Standard errors reported in parentheses; intercept not reported.

*
Signicant at 0.10 level.
**
Signicant at 0.05 level.
***
Signicant at 0.01 level.

accounting research, the full curve shows a negative relation
between the proportion of outside directors and the level of
earnings management indicating that, when agency problems are
signicant, board monitoring is more effective in rms with a
higher proportion of outside directors (e.g., Dechow et al., 1996;
Klein, 2002; Osma & Noguer, 2007; Peasnell et al., 2005).
In Fig. 3, the full line represents the effect of CEO duality on
earnings management when ownership is not 100% concentrated in
the hands of the family whereas the dotted line represents the effect
of CEO duality on earnings management when ownership is 100%
concentrated in the hands of the family. As in Fig. 2, in Fig. 3 the full
line is steeper than the dotted line implying that the effect of CEO
duality is stronger for rms facing agency problems due to the
conict between controlling and noncontrolling shareholders.
Hence, Hypothesis 2b is also supported. In line with prior accounting
research, the full curve shows a positive relation between CEO
duality and earnings management indicating that, when agency
problems are signicant, board monitoring is less effective in rms
that combine the positions of CEO and chairman (e.g., Cornett et al.,
2008; Dechow et al., 1996; Mather & Ramsay, 2006).
5. Discussion and conclusion
5.1. Contributions
While accounting literature has identied the board of
directors as one of the key constraining mechanisms on earnings
management, there is scant evidence on the role of the board in
limiting earnings management in the context of family rms (e.g.,
Beasley, 1996; Benkel et al., 2006; Dechow et al., 1996; Peasnell
et al., 2005). In this article, we try to ll this gap by building on the
conditional nature of corporate governance (Chi & Lee, 2010) to
enhance the understanding of the role of the board in constraining
earnings management in family rms. Based on the argument that
a governance mechanism becomes valuable when it meets the
rms control needs, we propose that the relationship between the
proportion of outside directors and CEO duality is stronger for
family rms facing agency problems due to the conict between
controlling and noncontrolling shareholders. Our empirical tests
indeed yield evidence in support of the conditional nature of the
inuence of the proportion of outside directors and CEO duality on
earnings management in a private family rm setting. As such, our
article contributes to the literature in several ways.
By linking board characteristics to the discretion managers have
in reporting earnings, this article takes up the challenge to increase
research efforts on the topic of corporate governance and
accounting choices in family rms (Salvato & Moores, 2010). By
taking up this challenge, we reinforce the ndings of Anderson and
Reeb (2004) in the context of earnings management. Our ndings
indicate that, in family rms, governance controls seem to have a
role in mitigating agency conicts among controlling and
noncontrolling shareholders. Moreover, by nding support for
the fact that, conditional on the presence of agency problems,
outside directors may have a constraining effect on earnings

0.2 0.2
0.19 0.19
0.18 0.18
0.17 0.17
0.16 0.16
0.15 0.15
0.14 0.14
0.13 0.13
Abs (DA)

Abs (DA)

0.12 0.12
0.11 0.11 <100%
0.1 <100%
0.09 0.1 100%
100% 0.09
0.08 0.08
0.07
0.06 0.07
0.05 0.06
0.04 0.05
0.03 0.04
0.02 0.03
0.01 0.02
0 0.01
Low proportion of outside High proportion of outside 0
directors directors CEO nonduality CEO duality

Fig. 2. Interactive effect of the proportion of outside directors and the presence of Fig. 3. Interactive effect of CEO duality and the presence of agency problems
agency problems between controlling and noncontrolling shareholders on the level between controlling and noncontrolling shareholders on the level of earnings
of earnings management. management.
90 A. Stockmans et al. / Journal of Family Business Strategy 4 (2013) 8492
management, our results suggest that the inclusion of outside
directors is an effective governance control when agency problems
are signicant. While prior research emphasized the advice role by
showing that the inclusion of outside directors depends mainly on
the ability of directors to provide advice rather than on their ability
to control the family, our results thus support the ndings of Van
den Heuvel et al. (2006) and Bammens et al. (2008) indicating that
although outside directors might be included for their advice role,
once included on the board they also fulll their legal duty of
controlling the family.
In addition, our article contributes to the stream of research
acknowledging the conditional nature of corporate governance. At
the basis of the corporate governance debate is the assumption
that corporate governance does not matter in the absence of
agency conicts and thus that the marginal value of governance
increases with the potential severity of agency problems (Hart,
1995; Jensen, 1986). Studies examining the relation between
governance and corporate outcomes, however, typically do not
control for differences in agency problems across rms. Only
recently, studies started to acknowledge the conditional nature of
the value of corporate governance. Chi and Lee (2010), for example,
detected signicant governance benets among rms with high
free cash ow whereas they nd a weak or insignicant link
between governance and rm value for rms with low free cash
ow. The results of our study extend this stream of research by
providing empirical evidence in an earnings management setting.
Also, by differentiating between different types of family rms
based on their board characteristics and the agency conicts
between controlling and noncontrolling shareholders they face,
this study contributes to the debate on family rm heterogeneity
(Corbetta & Salvato, 2004b; Sharma, 2004; Westhead & Howorth,
2007) and responds to the call for future research to focus on how
board roles and behaviors vary across different family business
types (Bammens et al., 2011).
Furthermore, the majority of empirical studies on earnings
management in family rms or family rms in general focuses on
public family rms. This focus on public rms is mainly driven by
the difculty of obtaining data on private rms and the argument
that issues facing private and public rms do not differ
substantially (Murphy, 2005). Yet research has shown that both
governance practices and earnings management behavior differ
when comparing public and private rms (Bammens et al., 2011;
Burghstahler et al., 2006). And since family rms are especially
prevalent among privately held SMEs, by focusing on a sample of
private family rms, this study thus adds to the empirical evidence
on earnings management behavior in an important yet under-
researched segment of rms.
5.2. Implications
Our study also has important practical implications. Firstly,
since earnings quality and more generally nancial reporting
quality are inversely related to the extent to which management
takes advantage of the discretion they have in reporting earnings
(Schipper & Vincent, 2003), insight into the factors that affect the
level of earnings management is important to understand which
inuences determine the quality of nancial reports. Examining
the conditional nature of corporate governance in a family rm
setting is therefore a step toward understanding which factors can
enhance a family rms nancial reporting quality. Especially in
private family rms, where nancial statements are usually the
only public source of information, a better understanding of the
quality of these nancial statements and the drivers behind it
could help nonfamily stakeholders in making more accurate credit
and investment decisions (Schipper & Vincent, 2003; Zhang, 2010).
In this regard, the inclusion of outside directors and the separation
of CEO and board chair roles may inuence external stakeholders
perception of the reliability of the family rms nancial reports.
And if external stakeholders believe informational opacity to be
low, family rms may be in a more favorable position to negotiate
contracts with these stakeholders. If, for example, banks perceive
family rms to be informationally opaque, this may result in credit
rationing and more stringent credit terms (Steijvers & Voordeckers,
2009). Therefore, if banks believe that nancial reporting quality is
higher, the credit-rationing problem may be lower and credit
terms may be less rigid. It would therefore be interesting for future
research to examine the link between the proportion of outside
directors or CEO duality and various features of the family rms
credit contract.
A second important practical implication of our study relates to
the debate on the need for (family) SMEs to implement a good
functioning board to control management. Increasing awareness of
the importance of good corporate governance for SMEs and
increasing institutional pressure has initiated corporate gover-
nance recommendations for these rms such as the Belgian Code
Buysse. This code clearly states that one of the main roles of an
active board of directors is to control management. By providing
evidence for the conditional nature of corporate governance, we
claim however that this view needs to be nuanced. After all, having
a controlling board is only efcient if agency conditions require the
need to control. Therefore, we claim that practitioners and
legislators should bear in mind that an active board can be an
important controlling mechanism only when agency problems
may be signicant. Moreover, practitioners need to be aware that
other conditional factors can determine the importance of the
board as a controlling mechanism. Family rms, for example, are
usually characterized by a high level of intentional trust (Bammens
et al., 2008). Exercising control when trust is high can have an
adverse effect since it limits pro-organizational behavior and
increases the tendency for opportunistic behavior in domains
where managers cannot be adequately controlled (Corbetta &
Salvato, 2004a).
5.3. Limitations
Next to the suggestions for future research presented through-
out this section, our study also has some limitations that provide
additional challenges for future research. First, given the small
sample size, this study although explorative in nature resulted in
interesting ndings. To validate the results of our study, however,
it would be interesting for future research to test the hypotheses
presented in this study using a larger sample size.
Second, to test our hypotheses we use a sample of Belgian
private family rms. Belgium can be classied as a French civil-law
country with a one-tier board system. As prior research has shown
that institutional differences such as, among others, differences in
legal systems (e.g., civil law versus common law countries) and in
corporate governance (e.g., one-tier versus two-tier board system)
may have an inuence on the extent of earnings management
(Renders & Vandenbogaerde, 2008), further research is necessary
to conrm our results for other institutional settings.
Finally, in this article the level of earnings management is
proxied by measuring the level of managers manipulation of
accruals also referred to as accounting earnings management.
Earnings management, however, can also be achieved by operating
manipulations (Dechow & Skinner, 2000; Elias, 2002). Operating
manipulations also known as real earnings management occur
through operational decisions that depart from normal operational
practices and have direct cash ow consequences (Dechow &
Skinner, 2000; Roychowdhury, 2006). Hence, it would be
interesting for future research to examine the role of the board
in controlling real earnings management instead of accounting
 A. Stockmans et al. / Journal of Family Business Strategy 4 (2013) 8492
earnings management conditional on the presence of agency
problems in family rms.
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