Re-examination of the Non-linear Relationship Between Management Ownership and Earnings Management: Evidence from Japan

Abstract

The purpose of this article is to provide further evidence on the functional form of relationship between management ownership and earnings management in the Japanese context. Applying regression model with third-order polynomial like Teshima and Shuto (2008), this study finds evidence of non-monotonic (cubic) relationship between management ownership and earnings management which supports alignment–entrenchment–alignment hypothesis. However, this study attempts to confirm the robustness of such findings with two additional approaches, namely piecewise linear regression and third-order polynomial regression with mean-centring adjustment. Unlike initial results, further evidence indicates that though the relationship between management ownership and earnings management is non-linear but the nature is quadratic (‘U’-shaped) which supports alignment–entrenchment hypothesis. Such conflicting findings will surely assist the future researchers to be cautious in designing non-linear models while investigating the relationship between ownership structure and earnings management.

Keywords

Discretionary accruals earnings management managerial entrenchment effect incentive alignment effect management ownership ownership structure

Get full access to this article

View all access options for this article.

References

Asteriou

Hall

S. G.

(2007). Applied econometrics . New York, NY: Palgrave Macmillan.

Basu

S. L.

Hwang

Mitsudome

Weintrop

(2007). Corporate governance, top executive compensation, and firm performance in Japan. Pacific Basin Finance Journal , 15(1), 56–79.

Berle

A. A.

Means

G. C.

(1932). The modern corporation and private property . New York, NY: Macmillan.

Borsch-Supan

Koke

(2002). An applied econometricians’ view of empirical corporate governance studies. German Economic Review , 3(3), 295–326.

Bos

Pendleton

Toms

(2013). Earnings management in the UK: Managerial shareownership, minority shareholder protection and discretionary accruals (SSRN Working Paper No. 1747919). DOI: 10.2139/ssrn.1747919

Bradley

R. A.

Srivastava

S. S.

(1979). Correlation in polynomial regression. The American Statistician , 33(1), 11–14.

Chen

Hexter

J. L.

M. Y.

(1993). Management ownership and corporate value. Managerial and Decision Economics , 14(4), 335–356.

Cheng

Warfield

T. D.

(2005). Equity incentives and earnings management. The Accounting Review , 80(2), 441–476.

Christie

Zimmerman

(1994). Efficient and opportunistic choices of accounting procedures: Corporate control contents. The Accounting Review , 69(4), 539–566.

10.

Chung

Firth

Kim

J. B.

(2002). Institutional monitoring and opportunistic earnings management. Journal of Corporate Finance , 8(1), 29–48.

11.

Cohen

D. A.

Dey

Lys

T. Z.

(2008). Real and accrual-based earnings management in the pre- and post-Sarbanes-Oxley periods. The Accounting Review , 83(3), 757–787.

12.

Dalal

D. K.

Zickar

M. J.

(2012). Some common myths about centering predictor variables in moderated multiple regression and polynomial regression. Organizational Research Methods , 15(3), 339–362.

13.

Darrough

M. N.

Pourjalali

Saudagaran

(1998). Earnings management in Japanese companies. The International Journal of Accounting , 33(3), 313–334.

14.

Davies

J. R.

Hillier

McColgan

(2005). Ownership structure, managerial behavior and corporate value. Journal of Corporate Finance , 11(4), 645–660.

15.

Dechow

P. M.

(1994). Accounting earnings and cash flows as measures of firm performance: The role of accounting accruals. Journal of Accounting and Economics , 18(1), 3–42.

16.

Dechow

P. M.

Skinner

D. J.

(2000). Earnings management: Reconciling the views of accounting academics, practitioners, and regulators. Accounting Horizons , 14(2), 235–250.

17.

Dechow

P. M.

Sloan

R. G.

Sweeney

A. P.

(1995). Detecting earnings management. The Accounting Review , 70(2), 193–225.

18.

Demsetz

Lehn

(1985). The structure of corporate ownership: Causes and consequences. Journal of Political Economy , 93(6), 1155–1177.

19.

Francis

J. R.

Maydew

E. L.

Sparks

H. C.

(1999). The role of Big 6 auditors in the credible reporting of accruals. Auditing: A Journal of Practice and Theory , 18(2), 17–34.

20.

Gabrielsen

Gramlich

J. D.

Plenborg

(2002). Managerial ownership, information content of earnings, and discretionary accruals in a non-U.S. setting. Journal of Business Finance and Accounting , 29(7–8), 967–987.

21.

Hair

J. F.

Anderson

R. E.

Tatham

R. L.

Black

W. C.

(1998). Multivariate data analysis (5th ed.). Upper Saddle River, NJ: Prentice Hall.

22.

Healy

P. M.

(1985). The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics , 7(1–3), 85–107.

23.

Healy

P. M.

Wahlen

J. M.

(1999). A review of the earnings management literature and its implications for standard settings. Accounting Horizons , 13(4), 365–383.

24.

Hill

R. C.

Griffiths

W. E.

Lim

G. C.

(2012). Principles of econometrics (4th ed.). Hoboken, NJ: John Wiley & sons, Inc.

25.

Jensen

Meckling

(1976). Theory of firm: Managerial behavior, agency costs and capital structure. Journal Financial Economics , 3(4), 305–360.

26.

Jones

J. J.

(1991). Earnings management during import relief investigations. Journal of Accounting Research , 29(2), 193–228.

27.

Kasznik

(1999). On the association between voluntary disclosure and earnings management. Journal of Accounting Research , 37(1), 57–81.

28.

Khan

Mather

(2013). The value of executive director share ownership and discretionary accruals. Accounting Research Journal , 26(1), 35–55.

29.

Kothari

S. P.

Leone

A. J.

Wasley

C. E.

(2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics , 39(1), 163–197.

30.

Leuz

Nanda

Wysocki

P. D.

(2003). Earnings management and investor protection: An international comparison. Journal of Financial Economics , 69(3), 505–527.

31.

Marsh

L. C.

Cormier

D. R.

(2002). Spline regression models . London: SAGE Publications.

32.

McConnell

J. J.

Servaes

(1990). Additional evidence on equity ownership and corporate value. Journal of Financial Economics , 27(2), 595–612.

33.

Mitchell

M. N.

(2012). Interpreting and visualizing regression models using Stata . College Station, TX: StataCorp LP.

34.

Mitra

Cready

W. M.

(2005). Institutional stock ownership, accrual management, and information environment. Journal of Accounting, Auditing & Finance , 20(3), 257–286.

35.

Mitra

Rodrigue

(2002). A methodological issue in earnings management research. Journal of Forensic Accounting , 3(2), 185–206.

36.

Morck

Shleifer.

Vishny

R. W.

(1988). Management ownership and market valuation: An empirical analysis. Journal of Financial Economics , 20(1), 293–315.

37.

Othman

H. B.

Zeghal

(2006). A study of earnings-management motives in the Anglo-American and Euro-Continental accounting models: The Canadian and French cases. The International Journal of Accounting , 41(4), 406–435.

38.

Rajgopal

Venkatachalam

Jiambalvo

(1999). Is institutional ownership associated with earnings management and the extent to which stock prices reflect future earnings? (SSRN Working Paper No. 163433). DOI: 10.2139/ssrn.163433

39.

Ruppert

(2011). Statistics and data analysis for Financial Engineering . New York, NY: Springer Science/Business Media LLC.

40.

Sakawa

Watanabel

(2008). Relationship between managerial compensation and business performance in Japan: New evidence using micro data. Asian Economic Journal , 22(4), 431–455.

41.

Sánchez-Ballesta

J. D.

García-Meca

(2007). Ownership structure, discretionary accruals and the informativeness of earnings. Corporate Governance: An International Review , 15(4), 677–691.

42.

Scherer

(1988). Corporate ownership and control. In Meyer

J. R.

Gustafson

J. M.

(Eds), The US business corporation (pp. 43–66). Cambridge: Ballinger.

43.

Scott

W. R.

(2012). Financial accounting theory . Toronto: Pearson/Prentice Hall.

44.

Shleifer

Vishny

R. W.

(1997). A survey of corporate governance. The Journal of Finance , 52(2), 737–783.

45.

Short

Keasey

(1999). Managerial ownership and the performance of firms: Evidence from the UK. Journal of Corporate Finance , 5(1), 79–101.

46.

Shuto

(2007). Executive compensation and earnings management: Empirical evidence from Japan. Journal of International Accounting, Auditing and Taxation , 16(1), 1–26.

47.

Teshima

Shuto

(2008). Managerial ownership and earnings management: Theory and empirical evidence from Japan. Journal of International Financial Management and Accounting , 19(2), 107–132.

48.

Velury

Jenkins

D. S.

(2006). Institutional ownership and quality of earnings. Journal of Business Research , 59(9), 1043–1051.

49.

Vogelvang

(2005). Econometrics theory and applications with EViews . London: Pearson Eduction.

50.

Warfield

T. D.

Wild

J. J.

Wild

K. L.

(1995). Managerial ownership, accounting choics and informativeness of earnings. Journal of Accounting and Economics , 20(1), 61–91.

51.

Wongrin

Rodchuen

Bookkamana

(2013, April 29–30). Application of independent variables transformations for polynomial regression model estimations . Paper presented at the 3rd International Conference on Applied Mathematics and Pharmaceutical Sciences (ICAMPS), Singapore.

52.

Yang

C. Y.

Lai

H. N.

Tan

B. L.

(2008). Managerial ownership structure and earnings management. Journal of Financial Reporting and Accounting , 6(1), 35–53.

53.

Yeo

G. H. H.

Tan

P. M. S.

K. W.

Chen

S.-S.

(2002). Corporate ownership structure and the informativeness of earnings. Journal of Business Finance and Accounting , 29(7/8), 1023–1046.

54.

Young

(1999). Systematic measurement error in the estimation of discretionary accruals: An evaluation of alternative modeling procedures. Journal of Business Finance and Accounting , 26(7/8), 833–862.