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Ownership Structure and AccountingInformation Content: Evidence from France
Ronald Zhao
Department of Accounting, Monmouth University, West Long Branch, NJ 07764-1898e-mail: [email protected]
Benedicte Millet-Reyes
Department of Economics and Finance, Monmouth University, West Long Branch,NJ 07764-1898e-mail: [email protected]
Abstract
This paper investigates how family and bank ownership affect the accounting informationcontent of French firms. In Continental Europe, the existence of block-holders triggers
specific corporate governance issues, including the transparency of financial reporting.
Our test results for the clean surplus model show that book value carries a significantly
greater weight for family-controlled firms. This finding is attributed to their lack of
incentive to report timely and relevant earnings to outside (minority) investors. In
contrast, bank owners are under more market pressure to achieve earnings persistence
through the use of accounting accruals. Bank ownership is also associated with higher
levels of debt. These results are consistent with findings that in code law countries, insidersdominate as a source of finance, and financial reporting is aimed at creditor protection.
1. Introduction
The objective of financial reporting is to provide investors with the
information they need to exercise their rights. Those rights, including
disclosure and accounting rules, are protected through the enforcement
of regulations. However, accounting information contents are not free
from the impact of corporate ownership and governance structure.Corporate governance mechanisms include a wide range of institutional
processes to organize and coordinate activities among various economic
agents (Williamson, 1985; North, 1990). They vary across countries due
to differences in levels of securities market development and environ-
mental factors. Shleifer and Vishny (1997) emphasize the importance of
legal systems in protecting the interests of the investors. There are two
competing models of corporate governance. The common law (market)-
based model prevails in the United Kingdom and the United States whilethe code law (control)-based model dominates in continental Europe,
We want to thank the editor and an anonymous reviewer for their valuable comments.
Journal of International Financial Management and Accounting 18:3 2007
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Japan, and in the emerging markets. The former is usually characterized
by an independent board, disperse equity ownership, transparent dis-
closure, and active takeover markets, while the latter emphasizes an
insider board, limited disclosure, and reliance on family/bank finance (LaPorta et al., 1998).
In market-based economies, shareholders are often viewed as moni-
tors of the firm by virtue of the size of their stake. The accounting
literature, based on the assumption of a close link between control rights
and cash flow rights, has focused on agency problems related to the
common law model. These issues include board composition, share-
holder activism, director compensation, anti-takeover provisions, and
the protection of dispersed investors. Much less is known about
corporate governance in code law countries, where stock markets do
not occupy a central position and where control rights and cash flow
rights are uncoupled.
Code law is generally associated with greater government intervention
in economic activity and weaker protection of private property than
common law. Strong political influence occurs at the national and firm
levels. In this environment, three main types of block-holders exercise
significant influence in corporate governance: families, financial institu-
tions, and the state, which are major sources of capital for publiclytraded firms. Government ownership can be found mostly in large
corporations, while family ownership is predominant in smaller firms.
Faccio and Lang (2002) report that family control is especially important
in Continental Europe, accounting for 44 per cent of their sample. In this
environment, voting rights are highly concentrated as compared with
that of the United States or the United Kingdom (Becht and Roell,
1999). Financial institutions often have significant control power in
excess of their cash flow rights (La Porta et al., 1999). Also, corporateownership structures become increasingly complex as a result of mergers,
pyramids, and cross-border investment activities.
In this context, the role of large shareholders as effective firm monitors
has gained much research interest in recent years. However, there is
limited evidence of their influence on financial reporting. This study
investigates the impact of two types of blockholders, families, and banks,
on the accounting information content of French firms. More specifi-
cally, we explore whether ownership structure affects reported earnings,accounting accruals, and the book value of equity versus debt. The
paper unfolds as follows: the next section reviews the characteristics
of corporate ownership and financial reporting in France. Section 3
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develops our theoretical foundations and three model hypotheses. Sec-
tion 4 provides data description and sample statistics. Section 5 discusses
our regression results, and Section 6 concludes the paper.
2. Literature Background
2.1. Family Control and Bank Ownership
The development of the French economy has differed significantly from
that of the major English-speaking countries. Historically, French stock
markets have not been the main channel for mobilizing risk capital, with
fewer listed companies and a relatively small aggregate market capitali-
zation compared with common law countries. Firms with closely con-
trolled ownership, often within families, are still prevalent. However, the
deregulation of capital markets in the late 1980s and the privatization of
French banks have led to an expansion of the Paris stock market (Millet-
Reyes, 2000). Two main exchanges gather most of the listed firms: the
First Market (Premier Marche) concentrates on large French and
multinational companies traded on a continuous basis; the Second
Market (Second Marche) allows medium-sized firms to be traded on a
continuous basis or by auction.In this context, large family ownership triggers specific corporate
governance issues in French firms. The quality of information disclosure,
the protection of minority shareholders and the independence of the board
are three factors that can affect corporate performance and reporting
mechanisms. However, evidence on family firms is limited because they are
often too small to use public markets. Anderson and Reeb (2003) find that
one-third of the S&P 500 firms in the United States have some form of
family ownership and that performance is enhanced when a familymember serves as the CEO. However, family entrenchment can become
a problem in countries where shareholders lawsuits and hostile takeovers
are unknown mechanisms. Minority stockholders may be powerless when
facing large controlling shareholders and pyramidal ownership structures.
Maury (2006) reports that in Western Europe, family control is associated
with higher stock valuation only in economies with good investor protec-
tion. Thomsen et al. (2006) use Granger tests to demonstrate that
blockholder ownership leads to lower subsequent firm value and account-ing profitability in control-based countries. Maury and Pajuste (2005)
provide evidence that corporate value is increased only when the second
largest shareholder is a non-family owner. They find that a more equal
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distribution of votes among large shareholders can mitigate governance
issues in family-controlled firms (Maury and Pajuste, 2005).
There is more theoretical and empirical evidence on bank ownership.
Shleifer and Vishny (1997) report a positive association between institu-tional ownership and firm value. Banks may own blocks of equity and
exercise proxy votes for their clients. They are perceived as long-term,
active, and informed investors who oversee corporate investments and
organize internal capital markets. Bank-owned firms benefit from their
lending relationship with banks and from privileged access to capital
markets. Therefore, banking relationships can mitigate the costs of
external financing and monitoring. However, critics argue that banks
enlarge agency problems when they control access to external capital
markets and issue loans to the firm (Wenger and Kaserer, 1998). Gordon
and Schmid (2000) hypothesize that banks can affect firm performance in
three ways. First, if there is a coincidence of interests between banks and
other shareholders, they will exert a benign influence and improve firm
performance. Second, if banks and other shareholders do not share the
same interests, banks will dominate as blockholders to the detriment of
minority shareholders. Finally, the relation between firm performance
and bank control may be downward sloping over some initial range of
ownership and then upward sloping. Stock markets may react in anegative way to bank owners if perceived as protecting their fixed claim
rather than providing a monitoring role.
2.2. Financial Reporting in France
In code law countries, the government establishes and enforces national
accounting standards. The French National Accounting Council (Conseil
National de la Comptabilite, CNC) issues the accounting code, PlanComptable General(PCG). The CNC is responsible for the establishment
of a national accounting language acceptable to all parties using financial
accounting information. However, some powerful groups such as large
companies and the tax administration have been involved in the CNC
decisions. Their concerns about tax-deductible allowances for deprecia-
tion and other unamortized expenditures are said to have dominated
many issues presented to the CNC (Choi and Meek, 2005; Nobes and
Parker, 2006).One of the central objectives of the PCG is to provide standardized
financial reports. The code prescribes regulations ranging from abstract
principles, such as prudence (prudence), consistency (regularite), and
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faithful reckoning (sincerite), to detailed procedures (e.g., the format of
financial statements). The application of the PCG is flexible in two major
respects. First, firms can choose between the abridged, standard, or
expanded version of accounts depending on their size and managementpreferences. While the abridged version is only applicable to enterprises
below a specified size, all medium and large firms can choose between the
standard (minimum accounting requirements) and expanded version.
The expanded version is meant for corporations wishing to facilitate
analysis of their management performance. Second, in recognition of
industry specificities, provisions exist to adjust the PCG to the account-
ing needs of particular industries. There are two categories of adjust-
ments: plans professionnels and plans de normalization comptable. One
unique feature of PCG is that it also presents an exposition on manage-
ment accounting, which is optional for all enterprises (Choi and Meek,
2005; Nobes and Parker, 2006).
The PCG fits into the structure of French commercial law. Its
mandatory core chart of accounts forms the basis for operation of the
accounting system, presentation of periodic accounts, and design of audit
programs. Their goal is to produce a true and fair view (image fidele) of
the position and operation of the enterprise. Because of Frances
historical focus on relations between persons (physical or incorporated),its accounting standards require careful recording of receivables/payables
and proofs of recorded transactions. However, French lawmakers have
been reluctant to embrace expanded technical possibilities in accounting
when these practices challenge existing regulations (e.g., use of market
value versus historical cost). This dependence on an overall scheme of
classification leads to significant differences with common law countries
where accounting information is a prerogative of enterprise management.
Previous studies show mixed results on the accounting informationcontent of financial reports by French firms. According to Saudagaran
and Biddle (1991) and Ball et al. (2000), financial statements prepared
under French (code law) Generally Accepted Accounting Principles
(GAAP) are found less transparent and timely than those prepared
under US (common-law) GAAP. Also, reported earnings have a higher
quality in the United States than in France. In contrast, Alford et al.
(1993) as well as Zhao (2002) provide evidence that the earnings quality
of French firms compares favorably to that of US firms. In this paper, weinvestigate the role of accounting as a monitoring tool for corporate
control. More specifically, we test whether variations in the accounting
information content of French firms may be attributed to the differences
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in their ownership structure. Three hypotheses are developed in the next
section.
3. Hypotheses Development
3.1. Earnings Reporting and the Motivation for Income Smoothing
The concept of income reporting as a primary source of investor decision
making is well documented in the accounting literature. The Study
Group on Business Income (Alexander, 1950) summarizes the uses of
income as (1) the basis of one of the principal forms of taxation, (2) a
measure of success of a corporations operations, (3) a criterion for
determining the availability of dividends, (4) a gauge by rate-regulating
authorities for investigating whether those rates are fair and reasonable,
(5) a guide to trustees charged with distributing income to a life tenant
while preserving the principal for a remainderman, and (6) as a guide to
management of an enterprise in the conduct of its affairs. These uses can
be correlated to varying degrees.
A firms reported earnings can be used to assess past performance and
predict future cash flows, which in turn influence security prices.
Reported earnings are subject to revenue recognition policies andmethods, the need to match revenues and expenses in certain time
periods, and managerial judgment. These motivations may affect the
quality of a firms earnings as measured by the degree of correlation
between its accounting income and its economic income. Earnings
management occurs either when GAAP allows management to provide
their private information (discretion), or when the reporting entity
intentionally deviates from the standard in making the measurement
(distortion) (Wilson, 1996). Healy and Wahlen (1999) list a variety ofreasons for earnings management, including influencing the stock mar-
ket, increasing management compensations, reducing the likelihood of
violating lending agreements, and avoiding intervention by government
regulations. The appropriateness of earnings management depends on its
objectives. Illegitimate earnings management aims to misrepresent earn-
ings to deceive investors and creditors, thus constituting financial
statement fraud. Dechow and Skinner (2000) describe the distinction
between conservative, neutral, aggressive, and fraudulent earnings man-agement activities.
The literature on code law countries reports that insiders have
incentives to manage reported earnings in order to mask the firms true
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performance. Inside owners tend to conceal their private control benefits
from outsiders through income smoothing. This is because the politiciza-
tion of accounting standards decreases the demand for timely reporting
and increases the need for income smoothing (Ball et al., 2000). In thiscontext, the quality of accounting income is influenced by the payout
preferences of inside stakeholders, such as families and banks, instead of
responding to the demand for public disclosure. Income smoothing
involves the manipulation of the time profile of earnings in order to
reduce the fluctuations of publicly reported income. However, it does not
necessarily increase reported earnings over the long run. It is an
important management tool because it enhances the investors ability
to predict future cash flows by reducing the variations of earnings.
Income smoothing can reduce bankruptcy risk as perceived by investors
and regulators. Moreover, the reduced risk may arguably lead to a lower
cost of capital, and thus a higher market valuation (Beaver and
Manegold, 1975; Bitner and Dolan, 1996). Trueman et al. (1988)
demonstrate that managers have incentives to present debt holders
with a low-variance income stream in order to reduce the required rate
of return and the firms long-term cost of capital. Banks are subject to
wide fluctuations in investments values and period losses on lending,
which can be disproportionate to single-year profits. Consequently, bankmanagement is known to have strong incentives for income smoothing
and earnings stability, which would lead to a beneficial effect on the
evaluation of their performance (Scheiner, 1981; Baht, 1996). In this
study, we hypothesize that the demand for stable earnings stream under a
code law system, combined with the banks concern for earnings stability,
should lead to income smoothing by bank-owned firms in France. In
contrast, it is difficult to specify ex ante, which techniques family-owned
firms may use to report firm performance as public financial statementsby families are not often available. However, we hypothesize that these
family shareholders do not share the same incentives as banks for
earnings reporting. We develop three hypotheses that test the differences
in accounting information content between bank- and family-owned
firms in France.
3.2. Reported Earnings and the Book Value of Equity: Families
Versus Banks
According to the clean surplus approach (Feltham and Ohlson, 1995;
Ohlson, 1995), accounting income is equal to the fiscal year change in the
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book value of equity adjusted for dividends and capital contributions.
The sum of the firms lifetime accounting income and its lifetime
economic income are identical. Therefore, the valuation of a firm consists
of its book value of equity, its current profitability as measured byearnings and other information items affecting the prediction of future
profitability. According to prior studies, family ownership tends to be
more dominant than bank ownership in France, thus having a crowding-
out effect on outside investors. As a result, bank-owned firms may have a
greater number of outside (minority) shareholders. Also, bank owners
will be more likely to influence security prices by reporting higher quality
earnings. In contrast, family owners will be more concerned about
protecting their ownership interest in the book value of equity, which
is the traditional approach in code law countries. The first hypothesis is:
H1: Ceteris paribus, earnings (book value) carries a greater weight for
bank-owned (family-owned) firms in France.
An expanded clean surplus model can be utilized to test the first
hypothesis:
Pit a b1BVit b2Eit b3Oit b4BVit Oi b5Eit Oi ei 1
where
Pit is the firm is stock price at the end of year t
BVit is the firm is book value of common equity per share for
year t
Eit is the firm is reported earnings per share for year t
Oi is the ownership percentage (bank and/or family)
BVit Oi is an interaction term between BVi and OitEit Oi is an interaction term between Ei and Oit
ei is a disturbance term
We test H1 on three ownership characteristics measured by the
variable Oi. In the first test, Oi is the percentage of family ownership;
in the second and third tests, it measures the percentage of bank
ownership. b4 and b5 measure the respective weights of book value and
current-period income based on the firms ownership structure. We
hypothesize that family-controlled firms have less incentives than banks
to provide full disclosure of current-period income because accounting iscostly, and the information asymmetry between managers and family
owners is solved through inside communication. Also, they are not under
pressure to report smooth earnings to outside minority investors.
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b4 is expected to be positive (negative) for family (bank) ownership, and
b5 negative (positive) for family (bank) ownership. These signs not only
reveal the value relevance of book value versus reported earnings but also
the linear information dynamic between the two items for firms underdifferent ownership structures. In the third test, the sample is limited to
companies where family ownership is greater or equal to 50 per cent and
Oi reflects the percentage of bank ownership. We add this test to
investigate the interaction between groups of blockholders who are in
a bid to protect their respective interests. Dye (1988) shows that an
external or investment demand for earnings management requires that
the firm be considered as a contractual arrangement with two distinct
groups of stakeholders, one of whom benefits from the effects of earnings
management at the expense of the other. The mechanism for assigning
the benefit is often based on the accounting price of some claims or
resources. To the extent that insiders differ in their incentives for asset
diversion, they would try to control the preparation and dissemination of
financial information in different ways to conceal their rent-seeking
activities. In France, family and bank owners are known to have control
rights over various aspects of corporate governance and management.
These powerful blockholders provide debt and equity capital to the firm,
which gives them privileged access to inside information. Their roles havesignificant implications for capital structure and earnings quality, thus
affecting the accounting information content of the firms balance sheet
and income statement. We expect that the addition of bank ownership to
family-owned firms would shift the weight from book value to reported
earnings for firms with joint family/bank ownership. This would reflect
the concern for public disclosure that bank owners face.
3.3. The Cash Flow and Accruals Components of Reported Earnings
Next, we test the impact of banks and family ownership on both the
operating cash flow and accounting accrual components of earnings.
Contrary to common law systems, code law countries allow for a greater
degree of income smoothing and users of accounting information favor
earnings persistence. Income smoothing can be achieved by exercising
more latitude in timing cash flow or income recognition. This is done in
order to drive down (up) cash flow/income in good (bad) years. Theeffectiveness of accounting accruals in ameliorating serial correlation in
operating cash flow is a fundamental feature of the accounting model of
income determination (Dechow, 1994). In general, operating cash flow
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can be viewed as a noisy version of accounting income. Accounting
accrual does not remove all the noise in operating cash flows. The
residual noise is independent of economic income and reduces the
timeliness of accounting income. In our second hypothesis, we testwhether the higher earnings persistence (quality) of bank-owned firms
conforms to the income-determination model.
H2: Ceteris paribus, bank ownership has a greater impact on the
operating cash flow and accounting accrual components of French firms
than does family ownership.
This hypothesis can be tested by dividing earnings into its operating
cash flow and accounting accrual components in the expanded cleansurplus-accounting model
Pit a b1BVit b2CFit b3ACit b4Oi b5BVitOi b6CFitOi b7ACitOi eI 2
where
CFit is the operating cash flow per share of firm i for year t
ACit is the accrual per share of firm i for year t.
All other variables are as previously defined. In this second model, b6and b7 are expected to have opposite signs because accounting accruals are
used to remove the negative serial correlation in operating cash flow (noise)
from current-period income. Also, b6 and b7 should differ significantly
based on ownership characteristics. As discussed in H1, family owners are
less interested in reporting value-relevant earnings to outside investors.
Therefore, the operating cash flow component should be more (less) noisy,
and accounting accruals less (more) significant in the reported income offamily (bank)-owned firms, resulting in the lower (higher) value relevance
of aggregate accounting income. b6 is expected to be negative (positive) for
family (bank) ownership and b7 positive (negative) for family (bank)
ownership, thus reflecting the relative information content of operating
cash flow and accounting accruals. In addition, we run the same test with a
sample split based on joint bank/family ownership.
3.4. The Book Value of Long-Term Debt Versus Equity
The third hypothesis concentrates on the analysis of balance sheet
information based on ownership categories. Accounting income
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incorporates only a subset of income statement information, whereas in
the clean surplus equation, economic income also incorporates in-
formation from the firms capital structure. An optimal capital mix
requires a composition of debt and equity to minimize the cost of capital.As banks and families supply both debt and equity capital to firms they
control, their roles generate potential ground for agency problems
between inside and outside shareholders, as well as between creditors
and equity holders. We decompose capital structure into its debt and
equity components and test their accounting implication for different
ownership characteristics. Based on the existing literature, we hypothe-
size that firms with bank owners are more likely to have broader and/or
cheaper access to long-term debt (Trueman et al., 1988) than family-
owned firms .
H3: Ceteris paribus, ownership structure creates significant differences
in the accounting information content of book value as a function of
debt and equity.
The following empirical model can be used to test H3:
MVit a b1
LDit b2
EQit b3
RESit b4
Oi b5
LDitOi b6EQitOi b7RESitOi ei 3
where
MVit is total market value of firm i at the end of year t
LDit is the long-term debt of firm i at the end of year t
EQit is the total shareholders equity of firm i at the end of year t
RESit is the total capital reserve of firm i at the end of year t
All variables, except for Oi (ownership percentage), are deflated by thesquare root of total assets. The interaction terms are as defined in the
previous model. Families and banks should have a significant influence
on financing and investing decisions because they are debt and equity
providers. b1 reflects the markets response to long-term debt financing
and should be negative as net assets decrease with debt. The interaction
term for debt and ownership, b5, measures the response to agency
conflicts between debt and equity holders. A negative (positive) sign
implies that markets react negatively (positively) to debt held by family(bank) firms. b6 and b7 measure the respective significance of the two
components of equity (Equity and Reserves) in the capital structure of
firms under different ownership structure. Both are expected to be
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positive for family ownership because book value carries a greater weight
in the linear dynamic framework (see H1). As banks are more inclined to
use capital reserve for both capital adequacy and earnings management
purposes, we expect a negative b7 for bank-owned firms to denote its lackof value relevance.
4. Data Description
The sample consists of 661 firm-year observations in a pooled sample,
covering 206 French non-financial firms over the period 19941998. All
firms are medium-sized corporations traded on the Second Market. They
are now included in Euronext Paris (created in 2000) and have the samelisting requirements as firms belonging to the First Market. In the late
1990s, three main trading categories were used on the Second Market.
The more-liquid firms were traded in two continuous categories (Con-
tinu A or Continu B) while the less-liquid firms were auctioned twice
a day (Fixing).
Table 1a provides ownership statistics for the full sample and for two
categories based on family and bank shareholdings (see description
below). The data are obtained from the publication Dafsa des liens
financiers, which reports all ownership stakes above 1 per cent. This
level of detailed information is crucial as bank ownership often falls
below the 5 per cent disclosure threshold set by the European Union. In
our sample, the average percentage of bank ownership (variable Bank) is
3.91 per cent, with a median of 0 per cent. Most firms are controlled by
families and individuals (variable Fam): the mean is 47.75 per cent and
the median 51.2 per cent. This is consistent with the results of Faccio and
Lang (2002) who report that 64.82 per cent of publicly listed firms in
234 Ronald Zhao and Benedicte Millet-Reyes
Table 1a. Ownership Statistics
VariableAllfirms
Family50%
Family450%
Bank5 0%
Bank40%
N 661 314 347 422 239Family (%)
Mean 42.75 14.14n 68.64n 46.83n 35.55n
Median 51.20 0n 66.4n 55.0n 46.3n
Bank (%)Mean 3.91 4.89n 3.04n 0n 10.83n
Median 0 0n 0n 0n 6.7n
nT-tests or non-parametric test indicate statistical significance at the 5% level.
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France are controlled at the 20 per cent level by families. Despite their
relatively small ownership percentage, banks can nevertheless exercise
effective monitoring. They can control the proxy votes of small share-
holders and put voting restrictions on the votes of non-bank block-
holders.
Table 1b provides financial statistics based on the ownership cate-
gories constructed in Table 1a. The variable definition for Table 1b is asfollows: MV is market value, BV is book value, EPS is earnings per
share, Op. CF is earnings before interest and taxes (EBIT) plus Accrual
where Accrual is measured as depreciation expense plus accruals. These
Ownership Structure and Accounting Information Content 235
Table 1b. Financial Statistics
Variable All firms Family50% Family450% Bank50% Bank40%
MV
Mean 45.38 47.92 43.09 44.33 47.24Median 33.47 40.25n 30.37n 33.34 34.85
BVMean 209.53 226.71n 193.99n 196.32n 232.86n
Median 149.85 158.08n 144.38n 134.18n 173.0n
EPSMean 14.93 16.78 13.26 15.40 14.11Median 13.91 15.70n 12.72n 13.35 15.76
LT DebtMean 177.29 173.36 180.85 165.65n 197.85n
Median 139.70 129.85nn 145.38nn 129.08n 155.24n
EquityMean 321.87 364.24n 283.53n 309.28nn 344.11nn
Median 247.69 283.85n 224.14n 229.29n 283.12n
ReservesMean 31.32 37.88n 25.38n 29.61 34.34Median 17.73 20.96n 14.16n 13.89n 23.16n
Op. CFMean 71.91 73.78 70.22 70.98 73.55Median 51.43 52.27 50.26 44.65n 57.05n
AccrualMean 32.93 33.44 32.46 32.24 34.14
Median 21.76 20.39 23.08 18.61
n
24.33
n
Op. CF/NIMean 3.61 3.29 3.90 3.75 3.35Median 2.85 2.71n 3.03n 2.81 2.99
Var EPSMean 1.58 1.44 1.70 1.86nn 1.09nn
Median 0.39 0.35nn 0.46nn 0.39 0.41
nT-tests or non-parametric test indicate statistical significance at the 5% level.nnT-tests and non-parametric tests indicate statistical significance at the 10% level.MV, market value; BV, book value; EPS, earnings per share; Op. CF, earnings before interestand taxes plus Accrualwhere Accrual is measured as depreciation expense plus accruals.
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variables are measured in millions of French Francs (FRF) per share.
The following numbers are divided by the square root of total assets and
measured in millions of FRF: LT Debt, Equity, and Reserves. Two
sample categories are then constructed to analyze our data. The first splitis based on the level of family ownership (less or greater than 50 per
cent). The threshold of 50 per cent is the median but it is also used to
ensure full control by families. T-tests and non-parametric tests show
that family-controlled firms have smaller book and market values. They
are also less likely to have bank owners. Second, the sample is split
based on bank shareholding. The sample includes 239 observations
where bank ownership is >0 per cent. T-tests and non-parametric tests
show that these firms have larger book values and higher levels of long-
term debt. These statistics are consistent with the results of Millet-Reyes
(2000) who reports that bank ties facilitate access to long-term bank
loans in France.
Next, we construct two variables to measure the variability of cash
flow and net income. The first one is calculated as the ratio of operating
cash flow divided by net income (Op.CF/NI). The descriptive results
show that family-controlled firms maintain a smaller gap between
reported earnings and operating cash flow. The second variable (var
EPS) is the absolute value of the percentage change in EPS betweenyears t and t 1. This ratio is larger for family-controlled companies andsmaller for firms with bank ownership. Also, accruals are statistically
higher (based on non-parametric tests) for companies with bank share-
holders. These results show that firms with large family shareholders
generate less earnings persistence than bank-owned firms. This supports
our hypothesis that bank shareholders are eager to smooth earnings for
outside investors. The next section provides a more detailed analysis of
this sample by using regression analysis and continuous variables forfamily and bank ownership.
5. Regression Results
Each of the three models (H1, H2, and H3) is run three times based on
the ownership categories of family (continuous ownership variable),
bank (continuous ownership variable), and joint family/bank ownership
(limited to firms with family ownership >50 per cent). A comparison ofthe three sets of results shows the significant impact of family versus bank
ownership on the accounting information content of French firms. We
added stock market liquidity and industry dummies in all models to
236 Ronald Zhao and Benedicte Millet-Reyes
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control for company and industry differences. These coefficients are
omitted in the result tables.
5.1. Model 1: Earnings Quality and Ownership Characteristics
Table 2 reports the regression results of the first model. The model
attains a significance at the .01 level for all three tests, resulting in an
adjusted R2 of .4136 and above for the three runs. The regression results
demonstrate a reasonable fit of the data and thus validate the overall
applicability of the clean surplus-accounting model with regard to the
empirical results.
b1 is a multiplicative parameter that relates book value to market
value. b2 is an earnings capitalization factor that takes into account the
cross-section variance in risk, expected growth and other factors. The
significantly positive signs for b1 and b2 denote a strong correlation
between market value, book value and earnings. b4 is positive for family
ownership, but negative for bank and joint family/bank ownership. The
positive interaction of book value with family ownership is consistent
with the emphasis on balance sheet in code law-accounting systems. In
France, accounting law has been shaped and reinforced by the policy
objectives of fiscal law. French fiscal law has imposed control upon theconstruction of the balance sheet by requiring that expenses be tax
deductible only if treated as such in the balance sheet. Costs and revenues
constructed through the income statement can be overridden by end-of-
period adjustments, therefore having a major impact on the final annual
accounts and estimated taxable income. In contrast, the significantly
negative interaction with bank ownership is accompanied by a corre-
sponding significantly positive interaction between reported earnings and
bank ownership (b5). This represents a transfer of weight from the bookvalue to reported earnings through the linear information dynamic
between the two items.
While b5 has a significantly positive coefficient for bank ownership, it
is significantly negative for family ownership. As family-owned firms
depend less on outside equity capital, there is correspondingly less
demand for transparency and timeliness in their reported earnings. Their
significantly negative b5 suggests that family ownership reduces the
information content of current reported earnings. The significantlypositive coefficient for bank ownership shows a greater emphasis on
current income. The increased weight of earnings and the decreased
weight of book value induced by bank ownership enhance the linear
Ownership Structure and Accounting Information Content 237
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238 Ronald Zhao and Benedicte Millet-Reyes
Table2.RegressionResultsforMo
del1
Ownership
Family
Ban
k
Family/Bank
Coe
fficient
t-statistic
Coefficient
t-statistic
Coe
fficient
t-statistic
Intercept
66.661
6.49nnn
66
.529
6.57nnn
68.654
2.85nnn
BV
0.051
4.00nnn
0
.095
11.56nnn
0.125
9.37nnn
E
0.441
5.42nnn
0
.197
4.57nnn
0.112
2.09nn
O
0.061
1.03
0
.069
0.28
0.782
1.39
BV
O
0.001
3.85nnn
0
.001
2.13nn
0.005
3.20nnn
E
O
0.004
2.58nnn
0
.025
3.97nnn
0.103
5.05nnn
N
661
661
347
F-value
25.67
25
.50
16.02
Pr4F
o.0001
o
.0001
o.0001
AdjustedR
2
0.4152
0
.4136
0.4520
nSignificant
atthe.1
level.
nnSignifican
tatthe.05level.
nnnSignificantatthe.01level.
BV,
bookv
alueofcommonequitypershare.E,reportedearningspersha
re.
O,percentageofownership.
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information dynamic between the two items in the clean surplus-
accounting framework.
The third set of tests measures the impact of joint family/bank ownership.
The results are different from those of family ownership alone (first test), butsimilar to those of bank ownership alone (second test). The interaction term
of joint family/bank ownership with book value (reported earnings), b4 (b5),
has a significantly negative (positive) sign. The shift in the weight from book
value to reported earnings results in a better fit of the clean surplus-
accounting model for firms with joint family/bank. These results indicate
that the addition of bank ownership to family-dominated firms is respon-
sible for a significant improvement in the accounting information content of
both book value and reported earnings. This suggests that banks provide an
effective monitoring role for financial reporting. Taken together, the three
sets of results provide empirical evidence supporting H1. The accounting
information content of both book value (normalized earnings) and current
period earnings (abnormal earnings) are significantly different for firms with
family versus bank owners.
5.2. Model 2: Earnings Components and Ownership Characteristics
Table 3 presents the regression results for H2. This model explores thelink between ownership structure and the value relevance of operating
cash flow and accounting accruals in reported earnings. The coefficients
of book value (b1), operating cash flow (b2), and accounting accruals (b3)
all have the expected signs. The positively significant coefficient of
operating cash flow with the three ownership categories indicates its
high value relevance as a major component of accounting earnings. The
negatively significant coefficient of accounting accruals in all three
groups reflects its offsetting role in removing the noise from operatingcash flow (Dechow, 1994). In the family ownership tests, the coefficient of
the interaction term (b5) with book value is significantly positive, which is
consistent with the test results of H1. Neither b6 nor b7 is significant,
suggesting that both components of accounting earnings lack value
relevance for family-owned firms.
The test results for bank ownership show a significantly positive
coefficient for the interaction term with operating cash flow (b6), and a
negative but insignificant coefficient for the interaction term withaccounting accruals (b7). The findings of Model 2 indicate that bank
ownership achieves higher earnings quality primarily through a higher
quality of operating cash flow.
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240 Ronald Zhao and Benedicte Millet-Reyes
Table3.RegressionResultsofModel2
Ownership
Fa
mily
Ban
k
Family/bank
Coe
fficient
t-statistic
Coe
fficient
t-statistic
Coe
fficient
t-statistic
Intercept
64.337
6.70nnn
63.691
6.63nnn
73.991
3.22nnn
BV
0.032
2.05nn
0.084
7.38nnn
0.109
5.66nnn
CF
0.539
7.98nnn
0.418
9.54nnn
0.341
5.25nnn
AC
0.799
6.93nnn
0.692
9.06nnn
0.605
4.78nnn
O
0.079
1.43
0.177
0.67
1.094
1.87nn
BV
O
0.001
3.82nnn
0.001
1.66nn
0.011
3.34nnn
CF
O
0.002
1.58
0.009
1.66nn
0.021
1.97nnn
AC
O
0.001
0.54
0.003
0.45
0.096
3.95nnn
N
661
661
347
F-value
31.51
29.71
17.87
Pr4F
o.0001
o.0001
o.0001
AdjustedR
2
0.4926
0.4774
0.5058
nSignificant
atthe.1
level.
nnSignifican
tatthe.05level.
nnnSignifica
ntatthe.01level.
BV,
bookv
alue.
CF,operatingcashflowp
ershare.
AC,accrualpershare
.O,ownershippercentage.
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The results for joint family/bank ownership are also significant. There
is a positive interaction with book value (b5), as well as a statistically
significant positive interaction with operating cash flow (b6). The
negative and significant interaction with accounting accruals (b7) em-phasizes the tension between bank and family owners in terms of income
determination. These results suggest that bank ownership mitigates the
negative effect of family control on earnings quality by removing the
noise in operating cash flow. This is carried out through a significant
increase in the use of accounting accruals. Overall, the test results
strongly support H2.
In both H1 and H2, earnings quality is measured by the predictability
of reported earnings to outside investors. Both models as well as our
descriptive statistics suggest that banks are more likely to engage in
income smoothing. Furthermore, our descriptive statistics show that
family ownership is associated with a higher variability in both Operating
Cash Flow and Earnings per Share. This validates the hypothesis that
bank-owned firms rely more on real earnings smoothing, which is
accomplished by timing investment or financing decisions to alter
reported earnings. Although bank shareholders use accounting accruals
to further reduce the noise from Operating Cash Flow in achieving a
target level in earnings, their emphasis on real earnings smoothingreduces the susceptibility of accounting accruals to earnings manipula-
tion. Incentives to reduce volatility in accounting earnings exist mostly in
code law countries. In France, accounting standards provide ample
latitude in timing income recognition to decrease income in good years
by asset-write-downs, provisions and transfer to reserves, and increase
income in bad years by reversing these accounting adjustments. The test
results for H1 and H2 provide empirical evidence that the opportunities
for income smoothing do not eliminate the usefulness of reportedearnings when valuing share prices in France (Ball et al., 2000; Schipper
and Vincent, 2003).
5.3. Model 3: Capital Structure and Ownership Characteristics
Table 4 lists the regression results of the third model. The test results for
the first category show that family ownership has a significant impact on
the accounting information content of the three capital structure com-ponents: Equity, Reserves and Debt. The interaction term of family
ownership with long-term debt (b5) is significantly negative. This result
shows that markets assign a higher cost to the debt financing of family-
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242 Ronald Zhao and Benedicte Millet-Reyes
Table4.RegressionResultsofModel3
Ownership
Family
Ban
k
Family/Bank
Coe
fficient
t-statistic
Coefficient
t-statistic
Coe
fficient
t-statistic
Intercept
583.876
16.47nnn
421
.419
13.30nnn
250.773
3.77nnn
LD
0.063
1.90nn
0
.156
5.64nnn
0.196
4.64nnn
EQ
0.097
4.56nnn
0
.191
10.13nnn
0.293
8.00nnn
RES
0.164
1.27
0
.287
2.79nnn
0.558
3.11nnn
O
0.560
3.07nnn
1
.134
1.22
2.080
0.96
LD
O
0.002
3.48nnn
0
.001
0.52
0.002
0.35
EQ
O
0.003
7.19nnn
0
.004
2.41nnn
0.007
2.52nnn
RES
O
0.011
3.86nnn
0
.019
1.34
0.091
3.17nnn
N
661
661
347
F-value
48.92
36
.92
18.41
Pr4F
o
.0001
o
.0001
o
.0001
AdjustedR
2
0.6039
0
.5333
0.5138
nSignificant
atthe.1
level.
nnSignifican
tatthe.05level.
nnnSignificantatthe.01level.
LD,
longte
rm
debt.EQ,totalshareholdersequity.RES,capitalreserves.
O,ownershippercentage.
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owned firms. In contrast, the interaction term of bank ownership with
long-term debt (b5) is positive (although insignificant), suggesting that
bank ownership mitigates the agency cost of debt. These results confirm
that highly persistent earnings numbers lead to a lower cost of debt(Trueman et al., 1988). The use of long-term debt as a viable option
for firms with bank owners is also verified by the financial statistics of
Table 1b.
The significantly positive coefficients for family ownership, b6 and b7,
denote a higher reliance on equity as markets recognize family control
rights in the two components of equity capital. While b6 is significantly
positive, b7 is insignificantly negative for bank ownership, suggesting a
higher cost of equity for using equity reserves to smooth earnings.
The regression results for the test of joint family/bank ownership
impact have the same signs as those for bank ownership. Banks play not
only a monitoring role in the case of pure bank ownership but also a
balancing role in the case of joint family/bank ownership. One noticeable
difference between bank and joint family/bank ownership is that b7 is
negative and insignificant (significant) for bank (joint family/bank)
ownership. This may be explained by the need to remove a higher level
of noise in operating cash flow through equity reserves. These results are
consistent with the findings of Meek and Thomas (2004) showing that incode law countries, banks dominate as a source of finance and that
financial reporting is aimed at creditor protection. Overall, the regression
results support H3. The accounting information content of book value as
a function of debt and equity capital differs based on ownership
structures.
5.4. Summary and Additional Comments on Regression Results
Several general observations can be made on the test results of the three
hypotheses. First, a comparison of Models 1 and 3 shows that Model 3,
which examines book value alone, has a higher adjusted R2 (4.5138)
than Model 1 (4.4136), which includes reported earnings. The higher
(lower) explanatory power of Model 3 (1) provides evidence on the
overwhelming weight of book value in code law countries data. Second,
an inverse association is identified between the operating cash flow and
accounting accruals components of accounting income. This demon-strates that the use of accounting accruals can provide economic
information by removing negative serial correlation in operating cash
flow. This process leads to higher earnings quality. Third, while bank
Ownership Structure and Accounting Information Content 243
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owners use of accounting accruals increases the information content of
reported earnings, it also decreases the significance of equity reserves as a
conduit for accounting accruals. Fourth, our empirical evidence suggests
that markets perceive family-controlled firms as more likely to haveincreased agency costs when using long-term debt. In summary, our
findings support the common characteristics of accounting information
content in code law countries as they have been reported in the literature.
However, our study demonstrates that the emphasis on book value
(income smoothing) is more significantly associated with family (bank)
ownership.
Last, we investigate whether our test results may be influenced by firm
size. Our sample shows a significant difference in the mean of book value
and equity between firm with and without family (bank) ownership
(Table 1b: Financial Statistics). However, our regression analysis con-
trolled for size in several ways. First, we used variables measured per
share in Models 1 and 2, and deflated all variables by a measure of size
(square root of total assets) in testing H3. Second, we included market
dummies that are usually correlated with size and liquidity (trading
category and length of time since IPO). All coefficients were statistically
significant in the three models, but they are not reported in the regression
tables. Third, we mixed two criteria (family control and bank ownership)in a separate category, which should mitigate the size impact in our
analysis.
6. Conclusion
Differences in accounting standards, corporate governance and disclo-
sure practices lead to significant discrepancies in the usefulness of
accounting information across countries. This study focuses on theimpact of ownership structure on the accounting information content
of book value and reported earnings in France. Our sample includes
medium-sized French firms with family, bank and/or joint family/bank
ownership. The market responds differently to the information content
of financial reporting based on ownership structure. Test results provide
evidence that book value carries a significantly greater weight in the clean
surplus-accounting equation and therefore weakens the linear informa-
tion dynamics for family-controlled firms. In contrast, bank-owned firmsreport highly persistent earnings through the use of accruals. They also
benefit from a broader or cheaper access to long-term debt, and stock
markets attach a larger valuation multiple to them.
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While sharing the characteristics of a blocked communication ac-
counting model, French firms exhibit significant in-group variances with
regard to financial reporting objectives and practice due to different
ownership structures. According to the agency theory, both families andbanks maximize their own expected utilities and are resourceful in doing
so. We see less conflict of interests with outside investors when firms
include banks as shareholders. This suggests that a more equal distribu-
tion of control rights among large shareholders can mitigate these issues,
especially in family-controlled firms. Bank ownership also leads to higher
earnings quality and mitigates the agency conflicts generated by debt
financing.
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