Corporate Disclosures by Family Firms

Family firms, debtholder–shareholder agency costs and the use of covenants in private debt

“…Wang (2006) argues that this greater transparency is likely due to the close alignment of interests of family members and other shareholders or because of the demands of the users of the financial statements of family firms. Ali et al (2007) argue that it is consistent with the relatively weak owner-manager conflict inherent in family firms. In either case, the higher reporting quality of family firms leads us to expect them to make greater use of restrictive covenants that rely on accounting numbers in their private debt contracts (relative to non-family firms), particularly if the firm has dual class shares and/or a family member is CEO.…”

“…In particular, the availability of reliable measures of the firm's performance as presented in its financial statements appears to be very important in helping borrowers and lenders reduce these agency costs and contract more efficiently. Further, the importance of financial statements to family firms in contracting is likely due to higher quality of financial disclosures produced by family firms, consistent with the closer alignment of owner and manager interests in such firms (Ali et al 2007;Wang 2006).…”

“…We also expect its severity to increase if the family's influence is increased through the presence of a family-member CEO and/or dual class stock, in which family members hold supervoting shares that give them significantly more control over important corporate decisions. 11 Prior research (Ali et al 2007;Wang 2006) provides evidence that the financial reports issued by family firms are of higher quality than those issued by non-family firms. Specifically, the earnings numbers provided by family firms are more predictive of future cash flows, elicit larger responses from investors and reflect less positive discretionary accruals than those provided by non-family firms.…”

“…3 One method of mitigating this agency cost, particularly in the case of private lending, is the inclusion of restrictive covenants that protect the lender(s) from the borrower using cash or assets in ways that increase the lender(s)' risk. Second, as just noted, prior accounting research provides evidence that family firms produce higher quality (more transparent) accounting reports than non-family firms due to the closer alignment of owner and manager interests in such firms (Ali et al 2007;Wang 2006). 4 Thus, restrictive covenants based on these higher quality accounting numbers are likely to be more useful in reducing the shareholder-private lender agency cost when the borrower is a family firm.…”

“…Anderson and Reeb (2003a) also provide evidence that family members tend to have a significant equity stake in their firms: On average, family members hold approximately 19% of their company's shares and have over 69% of their wealth invested in their firms. To date, accounting researchers have focused most of their efforts on studying the impact of founding family ownership structure on the incentives to produce transparent financial reports (Ali et al 2007;Wang 2006), provide voluntary disclosures (Chen et al 2008;Ali et al 2007;Anilowski et al 2007), and tie executive compensation contracts to accounting numbers (Chen 2005). The most robust findings from this body of work are that family firms tend to produce higher quality financial statements and warn about forthcoming negative earnings news more often than non-family firms, consistent with their having a less dominant owner-manager agency problem relative to nonfamily firms.…”