Journal of Accounting,

Auditing & Finance

Accounting Properties of XX(X) 1–18
Ó The Author(s) 2011
Chinese Family Firms Reprints and permission:
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DOI: 10.1177/0148558X11409147
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Shujun Ding1, Baozhi Qu2, and Zili Zhuang3

Abstract
We posit that family firms in China exhibit accounting properties consistent with the preva-
lence of Type II agency problems. In contrast to the owners of non-family firms, the
owners of family firms have more incentives to seek private benefits of control at the
expense of minority shareholders and provide lower-quality earnings for self-interested pur-
poses. The empirical evidence presented in this study suggests that the accounting earnings
of listed Chinese family firms are less informative, and family firms employ less conservative
accounting practices than their non-family counterparts. We also find that Chinese family
firms have higher discretionary accruals compared to non-family firms, which is consistent
with the view that family firms engage in more opportunistic reporting behavior. Overall,
our study suggests that family ownership in China is associated with lower earnings quality,
which is in sharp contrast to the findings of prior studies that examine such ownership in
the U.S.

Keyword
agency problems, accounting properties, family firms, China

Introduction
This study examines the accounting properties of family firms in China. The majority of
the world’s firms can be classified as family firms to some extent (Claessens, Djankov, &
Lang, 2000; La Porta, Lopez-de-Silanes, & Shleifer, 1999), and such firms thus play a criti-
cal role in modern economies. Recent studies examining the accounting properties of
family firms primarily focus on the United States and offer interesting results. Wang
(2006), for example, finds that founding family ownership is associated with more informa-
tive earnings, more conservative reporting, and lower discretionary accruals. Ali, Chen, and

1
University of Ottawa, Ontario, Canada
2
Skolkovo Institute for Emerging Market Studies, China
3
The Chinese University of Hong Kong

Corresponding Author:
Baozhi Qu, Skolkovo Institute for Emerging Market Studies, Unit 1608, North Star Times Tower, No. 8
Beichendong Road, Chaoyang District, Beijing, China, 100101
Email:[email protected]

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2 Journal of Accounting, Auditing & Finance

Radhakrishnan (2007) analyze the typical agency problems faced by family firms and find
that these firms report higher quality earnings. These important articles shed light on how
family ownership affects accounting properties and disclosure when Type I agency prob-
lems, which arise from the separation of ownership and management and thus can be miti-
gated by family ownership, dominate Type II agency problems, which stem from conflicts
between controlling and noncontrolling shareholders.
Fan and Wong (2002) find listed firms in East Asia to be characterized by less informa-
tive accounting earnings. This lack of high-quality information disclosure has been said to
be responsible, at least in part, for the 1997 Asian financial crisis (Ho & Wong, 2001). Fan
and Wong (2002) examine seven East Asian jurisdictions but exclude China. However, we
believe that examining the interactions among institutional arrangements, family ownership,
and accounting properties in China would offer important incremental insights. The coun-
try’s weak legal system makes it easier for controlling shareholders to expropriate minority
shareholders (the Type II agency problem), thus providing us with a good opportunity to
investigate whether family firms tend to have different disclosure incentives and hence,
exhibit different accounting properties, in an environment in which the Type II agency
problem is more pervasive than it is in developed markets such as the United States.
It is well recognized in the literature that Type II agency problems can lead to the
manipulation of accounting earnings by family firms. For example, Ali et al. (2007) suggest
that a variety of incentives arising from these agency problems may lead family firms to
manipulate accounting earnings to facilitate private benefit-seeking behavior. For instance,
these firms may be motivated to manipulate earnings to ‘‘hide the adverse effect of a
related party transaction’’ (p. 243). Ali et al. further point out that family owners usually
have a high level of influence over the firm’s board and top management, which is cer-
tainly the case in China. Hence, they are able to manipulate earnings more easily should
they choose to do so. Although legal institutions that are designed to protect the rights of
minority shareholders may help to mitigate the differences in Type II agency problems
between family and nonfamily firms, given that such institutions are either nonexistent or
ineffective in China (Allen, Qian, & Qian, 2005), family firms are expected to be subject
to more severe Type II agency problems and, accordingly, to have poorer earnings quality.
Using a sample of all listed nonstate firms in China from 2003 to 2006, we first examine
the informativeness of accounting earnings and find the reported earnings of family firms
to be less informative than those of nonfamily firms.1 We then use a piecewise serial
dependence model to test the relationship between family firms and the persistence of the
transitory loss components in earnings, which measures accounting conservatism. The
family firms in our sample are found to use less conservative accounting practices than
their nonfamily counterparts. Finally, we examine the relationship between discretionary
accruals and family firms and find these firms to have a higher level of such accruals. Our
results remain robust across different model specifications and to the inclusion of different
control variables.
The findings of this study make several contributions to the literature. First, we docu-
ment the importance of Type II agency problems to financial reporting. The effect of
agency conflicts on disclosure has been extensively investigated (see Healy & Palepu,
2001, for a review), and recent studies have examined the impact of family ownership on
corporate disclosure (e.g., Ali et al., 2007; Chen, Chen, & Cheng, 2008; Wang, 2006).
However, the aforementioned studies focus on the U.S. market, which is characterized by
Type I agency problems (e.g., Ali et al., 2007). Our focus on Chinese family firms offers
us an opportunity to isolate a setting in which Type II agency problems dominate. Our

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Ding et al. 3

investigation of the accounting properties of these firms thus provides insights that are
complementary to those of previous studies (e.g., Ali et al., 2007; Wang, 2006) examining
the way in which agency conflicts affect accounting properties.
Second, an examination of family firms in China, where privatization took place only
recently and the founders of family firms still run their firms directly, enables us to sharpen
our tests of the impact of family ownership on financial reporting and disclosure. In con-
trast to Chinese family firms, the majority of those in the United States are entrepreneurial
firms. The founders of U.S. family firms often hire professional managers. When these
founders retire, their families usually hold only ‘‘marginal ownership’’ (Burkart, Panunzi,
& Shleifer, 2003, p. 2168). Prior studies that use samples of U.S. family firms use either
the S&P 500 (e.g., Ali et al., 2007; Wang, 2006) or the S&P 1500 (e.g., Chen et al., 2008),
which may raise concerns about the sample (Hutton, 2007). Recent studies have shown that
findings involving family firms are ‘‘indeed sensitive’’ to the sample used (Miller, Breton-
Miller, Lester, & Cannella, 2007, p. 831); these authors have discovered that findings
based on Fortune 1000 firm data simply cannot be replicated in randomly drawn samples
of smaller public companies. By no means do we suggest that our study uses a noise-free
setting, but the early stages of both Chinese family firms and the Chinese stock market
may offer a more powerful context for our tests.
This study also differs from prior studies that examine ownership concentration in
East Asia (e.g., Fan & Wong, 2002) and earnings quality in China (e.g., Firth, Fung, &
Rui, 2007), none of which investigates the difference between family and nonfamily
firms. Furthermore, Fan and Wong (2002) did not include China in their sample, and Firth
et al. (2007) compare earnings quality between the country’s state- and nonstate-owned
firms. Our study focuses on the impact of family ownership on corporate disclosure and
thus adds to this literature.
The rest of the article proceeds as follows. The next section discusses China’s institu-
tional background. Section titled ‘‘Relevant Literature and Hypothesis Development’’
reviews the relevant literature and develops our hypothesis. Section titled ‘‘Sample and
Empirical Analysis’’ discusses our sample and empirical tests, and the last section con-
cludes the article.

Institutional Background of China

China had a centrally planned economy for the three decades following the birth of the
People’s Republic of China in 1949. The country’s economic reforms and opening-up
policy began in 1978 and initially focused on rural areas. In the 1980s, these reforms,
which blended central-planning elements with market-based practices, were extended
beyond the agricultural sector to state-owned enterprises (SOEs). It was not until 1992 that
the Chinese Communist Party formally announced, at its 14th National Congress, that
China was adopting a socialist market-based system. A significant chapter in the country’s
transition to this economic system was the establishment of the Shanghai and Shenzhen
Stock Exchanges in the early 1990s, and its capital markets have experienced unprece-
dented growth since then.
The majority of listed firms on the country’s stock market are the result of the corporati-
zation of SOEs. Typically, an operational unit of a large SOE was carved out, with its net
assets converted to nontradable shares at a certain rate. The remaining shares were then
issued to the public and can be traded. As in other countries in which the government
keeps a controlling stake in listed (and partially privatized) SOEs, the Chinese central and

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4 Journal of Accounting, Auditing & Finance

local governments remain, either directly or indirectly, the controlling shareholders of these
firms (Chen, Firth, Gao, & Rui, 2006). According to Chen et al. (2006), 30% of the shares
in a typical listed SOE are owned by the government or government-related agencies, and
another 30% are held by legal entities that are usually controlled by the state. The remain-
ing 40% are owned by individuals (including management and employees), private institu-
tions, and foreign investors. In non-SOE listed firms, the controlling shareholder may be a
family (discussed below) or some other type of nonstate entity (such as a foreign investor,
the firm’s employees, etc.).
Hence, the Chinese stock market presents two unique ownership features. First, although
all shareholders have the same rights, there are six types of shares: state, legal entity, for-
eign, management, employees, and other individuals (Firth, Fung, & Rui, 2007). The shares
held by state and legal entities cannot be traded on the market, whereas those owned by
individuals are actively traded. Second, ownership is highly concentrated. The state, and/or
a legal entity shareholder, often controls the listed company, and, typically, there are no
other block holders (Chen et al., 2006). Of the aforementioned six types of shares, those
held by management, employees, and foreign investors usually account for less than 3%
(Firth et al., 2007).
Relative to SOEs, private companies, including family firms, are a recent product of the
country’s economic reforms and opening-up policy. The first group of entrepreneurs gener-
ally comprised farmers and workers who had been laid off as a result of the SOE reforms.
It is estimated that around 140,000 such entrepreneurs started up family businesses in the
early 1980s. The expansion of economic reform has led to the rapid growth of these family
firms, which have had a presence in China’s capital market since its inception. In the first
10 years of this market’s establishment, the number of listed family firms increased annu-
ally by 83.8% (Zhang & Zhang, 2004). In all, 36% of these firms went public through
Initial Public Offerings (IPOs), 3% were listed through management buyouts, and the
remainder obtained listing status by acquiring existing listed companies (Zhang & Zhang,
2004). Although Chinese family firms have clearly become increasingly significant, sur-
prisingly, to the best of our knowledge, no one in the literature has studied the impact of
family ownership on the accounting properties among the nonstate firms in China.

Relevant Literature and Hypothesis Development

Agency Problems and Family Firms
Firms face two types of agency problems, both of which have significant implications for
the accounting properties of family firms (e.g., Ali et al., 2007; Wang, 2006). The first
type, known as Type I agency problems, results from the separation of ownership and con-
trol, and may lead managers to act in their own best interests rather than those of the share-
holders (Jensen & Meckling, 1976). Type I agency problems are typical in countries in
which ownership is diffuse, such as the United States. The second type of agency problem,
known as Type II, stems from the conflict between controlling and noncontrolling share-
holders (Ali et al., 2007), and is common in regions in which the ownership of listed firms
is usually concentrated in the hands of a single shareholder, as is generally the case in East
Asia (Fan & Wong, 2002). Both types of agency problems result in incentives and disin-
centives for accounting transparency and corporate disclosure.
Compared with their nonfamily counterparts, family firms usually exhibit different pat-
terns in both types of agency problems. Several factors influence the Type I agency

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Ding et al. 5

problems in these firms. First, family members usually hold positions among top manage-
ment or serve on the board of directors and are sometimes directly involved in the firm’s
operations. As a result, they usually have better knowledge of the daily operations of the
firm, which enables them to monitor managers more effectively and reduce opportunistic
behavior on the part of the latter (Anderson & Reeb, 2003). Second, family firms are long-
term oriented, and thus, the managers of these firms are less likely to seek short-term bene-
fits by manipulating accounting earnings (e.g., Chen et al., 2008). Third, family firms are
more sensitive to negative market events, such as litigation (Chen et al., 2008). For all of
these reasons, family firms may be less subject to the severe agency problems that often
arise from the separation of ownership and control and more likely to disclose higher qual-
ity earnings.
However, Type II agency problems may lead the controlling owners of these firms to
engage in opportunistic activities. Family owners may use their controlling positions in the
firm to expropriate outside shareholders through various channels, such as related-party
transactions (Anderson & Reeb, 2003) and freezing out minority shareholders (Gilson &
Gordon, 2003), and they may pursue their own interests at the expense of those of noncon-
trolling shareholders (Ali et al., 2007). Correspondingly, the controlling shareholders of
family firms have more incentives to hide relevant information by disclosing lower quality
earnings, as such opacity helps them to expropriate outside shareholders.
The severity of one type of agency problem over the other determines the quality of the
information that firms disclose. For example, the U.S. market is characterized by diffuse
ownership, and Type II agency problems are significantly alleviated due to the well-
established investor protection mechanisms in that country. As a result, Type I agency
problems tend to dominate Type II in the United States, which means that the family firms
there are more likely to disclose higher quality earnings, as family ownership mitigates
Type I problems. Ali et al. (2007) and Wang (2006) provide evidence to support this argu-
ment. Our study, in contrast, examines a setting in which Type II agency problems are
likely to be dominant, thus enriching our understanding of the impact of such agency prob-
lems on accounting properties.

Hypothesis Development
Both types of agency problems exist in China, although, as noted, Type II problems are
predominant for several reasons. First, the existence of dominant shareholders is a typical
feature of listed firms in China. Second, the country’s investor protection mechanisms are
weak, despite the rapid development of its macro-legal environment. The Chinese legal
system has been heavily influenced by the civil law tradition. La Porta, Lopez-de-Silanes,
Shleifer, and Vishny (1998) argue that legal protection for shareholders is weakest in coun-
tries with a civil law legal origin. Furthermore, Allen et al. (2005) provide evidence to
show that creditor and shareholder protection in China is even worse than that in other
major emerging markets. The existence of dominant shareholders, in conjunction with
weak protection for investors, renders Type II agency problems more salient, which helps
to explain why the China Securities Regulatory Commission, the country’s stock market
regulator, has repeatedly asserted that its top priority is strengthening minority shareholder
protection.
The governance mechanisms and incentive structure of family firms differ from those of
nonfamily firms in several important aspects, all of which have significant implications for
Type II agency problems. The key difference lies in their different ultimate controllers.

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6 Journal of Accounting, Auditing & Finance

Unlike family firms, which are controlled by an individual person and his or her family,
nonfamily firms are controlled by a group of legal entities, employees, or private investors,
including institutional investors. The benefits of expropriation for these controlling share-
holders, which are typically institutions, organizations, or a group of private investors that
are independent of one another, are thus diluted. As a result, the large shareholders of non-
family firms have fewer incentives to expropriate minority shareholders (Villalonga &
Amit, 2006). Family owners in China, in contrast, usually have absolute control over their
firm’s board and management and are less constrained by its corporate governance system.
Such a control structure makes it less costly for them to expropriate minority shareholders.
Furthermore, the private benefits of control are not diluted, as they all go to the family
owners. Family owners thus have stronger incentives to seek private benefits at the expense
of minority shareholders and may have more significant Type II agency problems com-
pared with nonfamily firms. Consequently, their disclosures tend to be more opaque for
self-interested purposes. For example, their accounting may be less informative, and their
earnings may be managed to bury the wealth effects (transfers) of their expropriation
activities.
Type I agency problems, in contrast, which arise from the separation of ownership and
management, are similar for family and nonfamily firms in China because, on average,
both have a concentrated ownership structure. Large shareholders are likely to monitor
management effectively and are sometimes directly involved in management. For example,
chairman of the board is an executive position in China. This chairman, who is presumed
to represent the interests of the controlling shareholder(s), is often directly involved in
operations (Chen et al., 2006). In addition, chief executive officers (CEOs) and other top
managers are usually appointed by the controlling shareholders (or, in some cases, are actu-
ally the founders or their family members).
In summary, compared with their counterparts in the United States, Chinese family firms
constitute a unique sample that is characterized by a higher degree of Type II agency prob-
lems. Consequently, we posit that Chinese family firms have different disclosure incentives
than such firms in the United States, and we thus put forward the following hypothesis.

Hypothesis: Family firms in China report lower quality accounting earnings than
their nonfamily counterparts.

Sample and Empirical Analysis

This section presents our empirical analyses. Our sample covers all non-state listed compa-
nies in China from 2003 to 2006. We exclude finance firms, although their inclusion has
no quantitative effect on our results. General accounting data and data on family firms are
obtained from the Guotaian (GTA) databases, which are widely used in accounting and
finance research using Chinese data (e.g., Haw, Qi, Wu, & Wu, 2005; Sun & Tong, 2003;
Wei, Xie, & Zhang, 2005). In this study, a family firm is defined as a firm that is con-
trolled by a private person and his or her family through direct stock ownership or through
a pyramid structure. In addition, for a firm to be considered a family firm, the ownership
stake of the controlling family owner (the largest shareholder) must be greater than or
equal to 10%. Given the short history of the Chinese stock market and the rarity of mergers
and acquisitions among the country’s listed companies, most, if not all, listed Chinese
family firms are still controlled by their founders and their families. The nonfamily firms
in our data set primarily include the following types of companies: dispersedly held

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Ding et al. 7

Table 1. Descriptive Statistics

Family firm Nonfamily firm

n M Median n M Median
RET 917 0.006 20.062 613 20.048*** 20.091**
EARNINGS 829 0.007 0.001 606 0.007 0.001
DNI 870 0.009 0.001 566 0.010 0.001
ABS_ACC 782 0.112 0.067 579 0.101 0.068
SIZE 922 20.764 20.729 619 20.814 20.850
BETA 841 1.117 1.110 592 1.091 1.100
MB 922 2.924 2.239 619 2.854 2.090
LEVERAGE 922 0.585 0.535 619 0.647*** 0.554**
LOSS 922 0.180 0.000 619 0.216* 0.000*
SEO 922 0.018 0.000 619 0.019 0.000
CFO 869 0.056 0.049 589 0.046** 0.044*
ROA 923 20.012 0.022 619 20.028** 0.018**
RETVOL 912 0.438 0.396 619 0.391*** 0.355***
MVE 922 1,553.690 1,016.750 619 1,498.132 1,084.356

Note: RET = cumulative market-adjusted returns over the 12-month period from 8 months before the fiscal year-end
to 4 months after it (that is, from May 1 of year t to April 30 of year t 1 1); EARNINGS = the annual change in net
income, deflated by the market value of equity at the beginning of the year; DNI the change in net income, calculated
as the net income of year t minus that of year t 2 1, scaled by the book value of equity at the beginning of year t;
ABS_ACC = the absolute value of discretionary accruals (performance-matched discretionary accruals calculated follow-
ing Ali, Chen, & Radhakrishnan, 2007); SIZE = the natural logarithm of the year-end book value of total assets; BETA =
the stock beta at year t; MB = the market-to-book ratio, calculated as the year-end share price divided by the book
value of equity per share; LEVERAGE = the leverage ratio of the firm at the end of the year, calculated as the year-end
book value of total liability divided by total assets; LOSS = a dummy variable that equals one if net income \ 0 and
zero otherwise; SEO = a dummy variable that equals one if the company has seasoned equity offerings and zero other-
wise; CFO = cash flow from operations scaled by beginning-of-year total assets; ROA = return on assets, measured by
net income divided by average total assets; RETVOL = annual stock volatility calculated using monthly stock returns
over the year; and MVE = the market value of equity, in millions of Chinese yuan.
*** indicates that the mean (or median) value of the variable for family firms is significantly different from that for
nonfamily firms at the 1% level; ** indicates a significance level of 5%; and * indicates a significance level of 10%.

companies with no controlling owner (or family), companies that are controlled by a group
of investors (who are not from the same family), companies that are controlled by a group
of legal entities (such as not-for-profit organizations, township and village organizations,
etc.), companies whose shares are held by employees or their unions, foreign-invested com-
panies, and other nonstate firms that are not family controlled.
Table 1 presents the descriptive statistics of our sample. On average, the family firms
are smaller and have a higher level of abnormal returns, lower leverage ratios, greater cash
flows from operations, greater profitability, and a higher level of return volatility than the
nonfamily firms. These characteristics suggest that family firms’ Type I agency problems
are at least not as severe as that of nonfamily firms even though both groups of firms have
similar level of ownership concentration, a result that is consistent with prior studies (e.g.,
Ali et al., 2007).2 Differences in accounting properties between family and nonfamily firms
are thus likely to be driven by Type II agency problems. Finally, at the bottom of Table 1,
we can see that both groups of firms have a similar degree of market capitalization.
Table 2 presents the sample distribution for family and nonfamily firms by year and
industry. The total number of both types of firms increased steadily from 2003 to 2006. Of
the 1,542 observations, approximately 59.8% are family firms, about two thirds of which

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8 Journal of Accounting, Auditing & Finance

Table 2. Sample Distribution by Year and Industry

Number of firms
Year Family firm Nonfamily firm Total
2003 99 198 297
2004 243 134 377
2005 271 126 397
2006 309 162 471
Total observations 922 620 1,542
Industry code
2: Utilities 86 63 149
3: Properties 57 28 85
4: Conglomerates 100 96 196
5: Industrials 625 379 1,004
6: Commerce 54 54 108
Total observations 922 620 1,542

are industrial firms. In the overall sample, the firms are from five different industries, with
the majority industrial firms (67.8% for family firms and 61.1% for nonfamily firms).
We examine three attributes of accounting earnings in Chinese family firms: earnings
informativeness; the persistence of transitory loss components in earnings, which is a mea-
sure of conservatism; and discretionary accruals. These three attributes have also been
examined in studies of the earnings quality of U.S. family firms (e.g., Ali et al., 2007;
Wang, 2006) and that of East Asian firms in general (Fan & Wong, 2002).3

Informativeness of Accounting Earnings

We follow the common practice in the literature to measure the informativeness of account-
ing earnings (e.g., Ali et al., 2007; Collins & Kothari, 1989) and examine whether those of
the family firms in our sample are less informative. The primary estimation model is given
by the following:

RET 5a1b1 EARNINGS1b2 EARNINGS3FAMILY 1b3 EARNINGS3SIZE1

b4 EARNINGS3BETA1b5 EARNINGS3MB1b6 EARNINGS3LEVERAGE1
b7 EARNINGS3RETVOL1INDUSTRY EFFECTS1YEAR EFFECTS1error;
ð1Þ

where RET represents cumulative market-adjusted returns over the 12-month period from
8 months before the fiscal year-end to 4 months after it (from May 1 of year t to April 30 of
year t 1 1), which includes the earnings announcement period; EARNINGS is the annual
change in net income,4 deflated by the market value of equity at the beginning of the year;
and FAMILY is a dummy variable that equals one if the firm is a family firm and zero other-
wise. Following the prior literature (e.g., Ali et al., 2007; Collins & Kothari, 1989), we
include the following control variables in our regression models: firm size (SIZE, which is

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Ding et al. 9

Table 3. Correlations Among Variables

RET EARNINGS SIZE BETA MB LEVERAGE LOSS SEO RETVOL

Family firms
RET 1.000
EARNINGS 0.194* 1.000
SIZE 0.040 20.041 1.000
BETA 0.027 0.094* 20.156* 1.000
MB 0.082* 0.026 20.100* 0.048 1.000
LEVERAGE 20.113* 0.026 20.202* 0.161* 20.116* 1.000
LOSS 20.218* 20.382* 20.230* 0.126* 20.003 0.417* 1.000
SEO 0.093* 0.083* 0.153* 20.024 0.010 20.037 20.064 1.000
RETVOL 0.157* 0.155* 20.263* 0.182* 0.083* 0.123* 0.070* 20.068* 1.000
Nonfamily firms
RET 1.000
EARNINGS 0.294* 1.000
SIZE 0.115* 20.050 1.000
BETA 0.043 0.143* 20.147* 1.000
MB 20.001 0.001 20.142* 20.073 1.000
LEVERAGE 20.148* 0.080* 20.288* 0.162* 20.199* 1.000
LOSS 20.275* 20.328* 20.297* 0.122* 20.002 0.471* 1.000
SEO 0.003 0.027 0.098* 20.031 20.015 20.074 20.074 1.000
RETVOL 0.016 0.062 20.250* 0.026 0.026 0.293* 0.308* 0.006 1.000

Note: RET = cumulative market-adjusted returns over the 12-month period from 8 months before the fiscal year-
end to 4 months after it (that is, from May 1 of year t to April 30 of year t 1 1); EARNINGS = the annual change in
net income, deflated by the market value of equity at the beginning of the year; SIZE = the natural logarithm of the
year-end book value of total assets; BETA = the stock beta at year t; MB = the market to book ratio, calculated as
the year-end share price divided by the book value of equity per share; LEVERAGE = the leverage ratio of the firm
at the end of the year, calculated as the year-end book value of total liability divided by total assets; LOSS = a
dummy variable that equals one if net income \ 0 and zero otherwise; SEO = a dummy variable that equals one if
the company has seasoned equity offerings and zero otherwise; RETVOL = annual stock volatility calculated using
monthly stock returns over the year.
* indicates that the correlation is significant at the 5% level or better.

the natural logarithm of the year-end book value of total assets); stock beta (BETA); growth
potential (MB, which is the market-to-book ratio, calculated as the year-end share price
divided by the book value of equity per share); risk of bankruptcy (LEVERAGE, which is the
leverage ratio of the firm at the end of the year, calculated as the year-end book value of
total liability divided by total assets); and return volatility (RETVOL, which represents annual
stock volatility and is calculated using monthly stock returns over the year). Finally,
INDUSTRY EFFECTS and YEAR EFFECTS are dummy variables that are included to control
for industry and time-fixed effects, respectively. To mitigate the undue influence of outliers,
the continuous variables used in our analysis are winsorized at the 1st and 99th percentiles.5
Simple correlation analysis (see Table 3) reveals that cumulative market-adjusted returns
and earnings are more positively correlated for nonfamily firms than they are for family
firms (both correlation coefficients are significant at the 5% level), which is consistent with
the supposition that family firms are characterized by less informative earnings.
Table 4 presents our estimation results. Robust standard errors adjusted for clustering
and heteroscedasticity are reported in parentheses for all of the coefficient estimates
(Petersen, 2009). Regression (1) in Table 4 is conducted to determine whether firm

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 10
Table 4. Earnings Informativeness and Family Firms

Regression Models
Dependant variable: RET (1) (2) (3) (4) (5)
Constant 0.038 (0.036) 0.036 (0.038) 0.037 (0.038) 0.038 (0.038) 0.031 (0.039)
EARNINGS 0.704*** (0.097) 0.876*** (0.111) 20.082 (2.469) 0.022 (2.471) 20.696 (2.517)
EARNINGS3FAMILY — 20.201** (0.085) 20.166** (0.085) 20.180** (0.086) 20.157* (0.086)
EARNINGS3SIZE — — 0.063 (0.110) 0.056 (0.110) 0.083 (0.112)
EARNINGS3BETA — — 0.083 (0.293) 0.082 (0.294) 0.203 (0.301)
EARNINGS3MB — — 0.043** (0.022) 0.046** (0.022) 0.041* (0.023)
EARNINGS3LEVERAGE — — 20.530* (0.301) 20.534* (0.301) 20.527* (0.305)
EARNINGS3RETVOL — — 20.114 (0.791) 20.060 (0.792) 20.001 (0.812)
INDUSTRY EFFECTS Yes Yes Yes Yes Yes
YEAR EFFECTS Yes Yes Yes Yes Yes
Adjusted R2 .058 .061 .081 .081 .080
No. of observations 1,424 1,424 1,349 1,342 1,268

Note: The dependent variable is RET, which is cumulative market-adjusted returns over the 12-month period from 8 months before the fiscal year-end to 4 months after it
(from May 1 of year t to April 30 of year t 1 1); EARNINGS = the annual change in net income, deflated by the market value of equity at the beginning of the year; FAMILY = a
family dummy that equals one if the firm is a family firm and zero otherwise; SIZE = the natural logarithm of the year-end book value of total assets; BETA = the stock beta at
year t; MB = the market-to-book ratio, calculated as the year-end share price divided by the book value of equity per share; LEVERAGE = the leverage ratio of the firm at the

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end of the year, calculated as the year-end book value of total liability divided by total assets; RETVOL = annual stock volatility calculated using monthly stock returns over the
year; INDUSTRY EFFECTS = dummy variables that control for industry fixed effects; and YEAR EFFECTS = dummy variables that control for calendar year fixed effects. In
Regression (4), firms that issue both A shares (in the mainland Chinese stock markets) and H shares (in the Hong Kong stock market) are excluded from the sample; in
Regression (5), real estate firms are excluded. Continuous variables are winsorized for exceptionally high/low values. Standard errors (in parentheses) are robust standard
errors adjusted for clustering and heteroscedasticity. Values are bold to highlight rows of our focal interest.
*** indicates a significance level of 1%, ** indicates a significance level of 5%, and * indicates a significance level of 10%, all two-tailed.
Ding et al. 11

earnings are generally informative, with a positive sign expected for b1. The estimation
result generally confirms this expectation, with the coefficient being positive and highly sig-
nificant. The sign of this coefficient estimate also remains positive in Regression Model (2).
In Regressions (2) and (3) in Table 4, the main coefficient of interest is that of
EARNINGS 3 FAMILY. If it is positive, then family firms’ earnings are more informative
than those of their nonfamily counterparts. A negative coefficient would indicate the oppo-
site. Family firms are found to disclose less informative earnings, as the coefficient estimates
have a negative sign in both of these regression models and are significant at the 5% level.
Our results remain robust across different model specifications and after controlling for
variables that are commonly used in the literature (e.g., Ali et al., 2007; Collins & Kothari,
1989; Wang, 2006), including firm size, stock beta, leverage, the effects of growth (MB),
stock price characteristics, and the like. The coefficients on the control variables, when sig-
nificant, have the expected signs (except for that on EARNINGS 3 BETA). For example,
firms with better growth potential tend to report more informative earnings, and those with
a greater degree of leverage less informative earnings. In addition, because firms that issue
both A shares in the mainland Chinese stock markets and H shares in the Hong Kong stock
market are likely to be subject to more stringent monitoring and accounting quality regula-
tions, we run a sensitivity test by excluding firms with dual A and H shares (column 4 of
Table 4). Our main results hold in this test. Finally, column 5 presents the estimation
results with real estate firms excluded from the sample. Our main results are unchanged,
but the coefficient estimate becomes only marginally significant. Our estimates may thus
be sensitive to the exclusion of certain industries such as property and real estate in the
sense that the significance level of our estimation results is somehow reduced by their
exclusions.

Persistence of Transitory Loss Components in Earnings

Researchers have long argued that the transitory loss components in earnings are less per-
sistent than positive earnings changes, possibly as a result of the conservative nature of
accounting earnings (Basu, 1997). In this section, we use a piecewise serial dependence
model (Ball & Shivakumar, 2005; Basu, 1997; Wang, 2006) to test the relationship
between family firms and the persistence of transitory loss components in earnings.6 The
primary estimation model is given by

DNIt 5a1b1 DDNIt1 1b2 DNIt1 1b3 DNIt1 3DDNIt1 1

b4 FAMILYt 1b5 DDNIt1 3FAMILYt 1b6 DNIt1 3FAMILYt 1
b7 DNIt1 3DDNIt1 3FAMILYt 1b8 SIZEt 1b9 DDNIt1 3SIZEt 1
b10 DNIt1 3SIZEt 1b11 DNIt1 3DDNIt1 3SIZEt 1 ð2Þ
b12 LEVERAGEt 1b13 DDNIt1 3LEVERAGEt 1b14 DNIt1 3
LEVERAGEt 1b15 DNIt1 3DDNIt1 3LEVERAGEt 1
INDUSTRY EFFECTS1YEAR EFFECTS1error;

where DNIt is the change in net income, calculated as the net income of year t minus that
of year t 2 1 and scaled by the book value of equity at the beginning of year t; DNIt1 is
the change in net income in year t 2 1; and DDNIt1 is a dummy variable that equals one
if DNIt1 is negative and zero otherwise. All of the other variables are as previously

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 12
Table 5. Persistence of Transitory Loss Components in Earnings and Family Firms

Regression Models
Dependent variable: DNIt (1) (2) (3) (4)
Constant 0.045 (0.033) 20.094 (0.274) 20.095 (0.280) 20.079 (0.282)
DDNIt1 20.040* (0.024) 0.377 (0.380) 0.322 (0.383) 0.437 (0.393)
DNIt1 20.035 (0.068) 0.210 (0.519) 0.219 (0.526) 0.268 (0.530)
DNIt1 3DDNIt1 20.260*** (0.048) 1.799*** (0.666) 1.772*** (0.665) 1.765*** (0.665)
FAMILYt 0.031 (0.021) 0.034* (0.019) 0.034* (0.020) 0.045** (0.020)
DDNIt1 3FAMILYt 20.010 (0.031) 0.012 (0.028) 0.013 (0.028) 20.007 (0.028)
DNIt1 3FAMILYt 20.008*** (0.002) 20.006* (0.003) 20.006* (0.003) 20.006* (0.003)
DNIt1 3DDNIt1 3FAMILYt 0.218*** (0.048) 0.313*** (0.061) 0.314*** (0.062) 0.324*** (0.062)
SIZEt — 0.011 (0.014) 0.011 (0.015) 0.008 (0.015)
DDNIt1 3SIZEt — 20.016 (0.019) 20.013 (0.019) 20.017 (0.020)
DNIt1 3SIZEt — 20.017 (0.025) 20.017 (0.025) 20.018 (0.025)
DNIt1 3DDNIt1 3SIZEt — 20.109*** (0.034) 20.108*** (0.034) 20.108*** (0.033)
LEVERAGEt — 20.119 (0.099) 20.122 (0.099) 20.062 (0.100)
DDNIt1 3LEVERAGEt — 20.196 (0.126) 20.182 (0.127) 20.243 (0.129)
DNIt1 3LEVERAGEt — 0.028 (0.153) 0.039 (0.153) 0.011 (0.158)
DNIt1 3DDNIt1 3LEVERAGEt — 20.066 (0.050) 20.063 (0.050) 20.066 (0.049)
INDUSTRY EFFECTS Yes Yes Yes Yes
YEAR EFFECTS Yes Yes Yes Yes
Adjusted R2 .110 .197 .182 .185
No. of observations 1,350 1,350 1,343 1,270

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Note: The dependent variable is DNIt , which is the change in net income, calculated as the net income of year t minus that of year t 2 1, scaled by the book value of equity at
the beginning of year t; DDNIt1 = a dummy variable that equals one if DNIt1 \ 0 and zero otherwise; FAMILY = a family dummy that equals one if the firm is a family firm and
zero otherwise; SIZE = the natural logarithm of the year-end book value of total assets; LEVERAGE = the leverage ratio of the firm at the end of the year, calculated as the year-
end book value of total liability divided by total assets; INDUSTRY EFFECTS = dummy variables that control for industry fixed effects; and YEAR EFFECTS = dummy variables that
control for calendar year fixed effects. In Regression (3), firms that issue both A shares (in the mainland Chinese stock markets) and H shares (in the Hong Kong stock market)
are excluded from the sample; in Regression (4), real estate firms are excluded. Continuous variables are winsorized (1% in each tail). Standard errors (in parentheses) are
robust standard errors adjusted for clustering and heteroscedasticity. Values are bold to highlight rows of our focal interest.
*** indicates a significance level of 1%, ** indicates a significance level of 5%, and * indicates a significance level of 10%, all two-tailed.
Ding et al. 13

Table 6. Discretionary Accruals and Family Firms

Regression Models
Dependent variable: ABS_ACC (1) (2) (3)
CONSTANT 0.135*** (0.016) 0.394** (0.160) 0.394** (0.164)
FAMILY 0.014* (0.009) 0.016* (0.008) 0.016* (0.008)
SIZE — 20.015* (0.009) 20.015* (0.009)
LEVERAGE — 0.046 (0.029) 0.046 (0.029)
MB — 0.005 (0.005) 0.005 (0.005)
LOSS — 20.042*** (0.012) 20.043*** (0.012)
CFO — 20.050 (0.076) 20.050 (0.077)
ROA — 20.112 (0.111) 20.116 (0.114)
SEO — 20.004 (0.017) 20.005 (0.017)
INDUSTRY EFFECTS Yes Yes Yes
YEAR EFFECTS Yes Yes Yes
Adjusted R2 .019 .053 .052
No. of observations 1,283 1,283 1,276

Note: The dependent variable is ABS_ACC, which is the absolute value of discretionary accruals (performance-
matched discretionary accruals calculated following Ali et al., 2007); FAMILY = a family dummy that equals one if
the firm is a family firm and zero otherwise; SIZE = the natural logarithm of the year-end book value of total
assets; MB = the market to book ratio, calculated as the year-end share price divided by the book value of equity
per share; LEVERAGE = the leverage ratio of the firm at the end of the year, calculated as the year-end book value
of total liability divided by total assets; LOSS = a dummy variable that equals one if net income \ 0 and zero other-
wise; SEO = a dummy variable that equals one if the company has seasoned equity offerings and zero otherwise;
CFO = cash flow from operations scaled by beginning-of-year total assets; ROA = return on assets, measured by net
income divided by average total assets; INDUSTRY EFFECTS = dummy variables that control for industry fixed
effects; and YEAR EFFECTS = dummy variables that control for calendar year fixed effects. Real estate firms are
excluded from the regressions. In Regression (3), firms that issue both A shares (in the mainland Chinese stock
markets) and H shares (in the Hong Kong stock market) are excluded from the sample. Continuous variables are
winsorized (1% in each tail). Standard errors (in parentheses) are robust standard errors adjusted for clustering
and heteroscedasticity. Values are bold to highlight rows of our focal interest.
*** indicates a significance level of 1%, ** indicates a significance level of 5%, and * indicates a significance level of
10%, all two-tailed.

defined. The coefficient of interest on DNIt1 3DDNIt1 3FAMILYt captures the incre-
mental difference in accounting conservatism between family firms and nonfamily firms
(Ball & Shivakumar, 2005). A positive b7 would suggest that the former are less conserva-
tive in accounting (lower earnings quality) than the latter and vice versa.
Table 5 reports the estimation results. Similar to those reported in the previous section,
the robust standard errors adjusted for clustering and heteroscedasticity are reported in par-
entheses. The coefficient estimates on DNIt1 3DDNIt1 3FAMILYt are positive in both
Regression Models (1) and (2), and are significant at the 1% level, which means that
family firms use less conservative accounting than do nonfamily firms. Following the argu-
ments in the prior literature (Ball & Shivakumar, 2005; Wang, 2006), this finding provides
evidence to indicate that Chinese family firms issue lower quality financial reports than do
nonfamily firms.
Another interesting result from Model 2 of Table 5 is that the coefficient estimate on
DNIt1 3DDNIt1 3SIZE t is significantly negative (at the 1% level), thus indicating
that larger firms are more conservative, which is consistent with the notion that
such firms may provide higher quality financial reports. In general, the overall regression

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14 Journal of Accounting, Auditing & Finance

models are highly significant. Industry and year dummies are again included to
control for fixed industry and time effects, and, similar to the previous section, we run
sensitivity tests by excluding A and H dual share firms (Regression 3 in Table 5) and real
estate firms (Regression 4 in Table 5) from the sample, but the main results remain
unchanged.
It must be stated here that the usual caveat applies when interpreting these findings.
As Ball and Shivakumar (2005) and Wang (2006) point out, the serial dependence model
(Basu, 1997) is limited by its potential inability to distinguish the transitory components
in earnings from random accruals errors and from some types of earnings management.
In addition, this model may be unable to determine whether the recognition of the transi-
tory loss components in earnings is timely or untimely (Ball & Shivakumar, 2005).

Discretionary Accruals
Following the literature (e.g., Ali et al., 2007; Ashbaugh, LaFond, & Mayhew, 2003), we
estimate the following model to examine the relationship between discretionary accruals
and family firms:

ABS ACC5a1b1 FAMILY 1b2 SIZE1b3 LEVERAGE1b4 LOSS1b5 CFO

1b6 ROA1b7 SEO1b8 MB1INDUSTRY EFFECTS ð3Þ
1YEAR EFFECTS1error:

The dependent variable ABS_ACC is the absolute value of discretionary accruals, which
are performance-matched discretionary accruals calculated as in Ali et al. (2007). More
specifically, we match firms by return on assets (ROA) within their industry, that is, utili-
ties, conglomerates, industrials, and commerce, with the property and real estate industry
excluded from this analysis.7 We include control variables following the literature (e.g., Ali
et al., 2007; Wang, 2006). Specifically, we control for the risk of bankruptcy
(LEVERAGE), firm size (SIZE), and growth potential (MB). Firms may manage their earn-
ings to meet the regulatory standards for stock rights offerings, and we thus control for this
effect by including a SEO dummy that equals one if the firm had a seasoned equity offering
and zero otherwise. CFO is defined as cash flows from operations scaled by total assets at
the beginning of the year, and ROA is the current year’s return on assets. LOSS is a dummy
variable that equals one if net income \ 0 and zero otherwise. All of the other variables
are as previously defined. Finally, we include industry and year dummies to control for
time and industry effects. A positive coefficient on the family dummy would indicate that
family firms are associated with a higher level of discretionary accruals.
The descriptive statistics reported in Table 1 suggest that the mean value of ABS_ACC
for family firms is higher than that for nonfamily firms, although the difference is statisti-
cally insignificant. Table 6 reports the multiple regression results with the robust standard
errors adjusted for clustering and heteroscedasticity in parentheses. The coefficient esti-
mates of the family dummy in Models 1 and 2 are significantly positive at the 10% level,
thus indicating that the level of discretionary accruals is higher for family firms than for
their nonfamily counterparts and that greater opportunistic reporting behavior exists among
the former. If a higher level of discretionary accruals proxies for lower quality earnings,
then this result is consistent with those on earnings informativeness and conservatism.

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Ding et al. 15

These findings are robust to the inclusion of the various control variables commonly
used in the literature, and the signs of the coefficients on these variables are also generally
consistent with the prior literature. For example, the coefficient on SIZE is negative and
significant at the 10% level, which suggests that large firms have a lower level of discre-
tionary accruals. The coefficient on LOSS has a negative sign, which may reflect the
greater degree of monitoring by the government and the market that loss firms receive in
China, thus making it more difficult for these firms to manipulate earnings.8 In addition, as
previously stated, if a firm issues both A shares on the Shanghai or Shenzhen stock
exchange and H shares on the Hong Kong exchange, then it may be subject to greater regu-
latory scrutiny and therefore less likely to manage earnings. As a sensitivity test, we
exclude dual A and H share firms from our sample (column 3 of Table 6), but our main
results hold. However, caution must be exercised in interpreting our discretionary accruals
results, as the FAMILY coefficient is only marginally significant across all of the regres-
sions in Table 6.
In summary, using a portfolio of earnings quality measures, including earnings informa-
tiveness, conservatism, and discretionary accruals, we find evidence that is consistent with
the notion that family firms in China exhibit certain accounting properties that stem from
Type II agency problems.

Conclusion
Family firms have become an increasingly important area of research (e.g., Bennedsen,
Nielsen, Perez-Gonzalez, & Wolfenzon, 2007). Previous accounting studies using U.S.
family firm data provide evidence on the degree of transparency and disclosure in these
firms when Type I agency problems dominate. However, compared with U.S. family firms,
which are usually managed and controlled by professional managers, those in Asian econo-
mies, including China, are more pervasive and diverge more from their nonfamily counter-
parts. Because of the weak investor protection mechanisms and less-advanced market
development in these economies, Type II agency problems are likely to play a larger role.
The use of Chinese data thus helps to alleviate some of the data problems seen in U.S.
studies and to isolate Type II agency problems, which has sharpened our tests of the inter-
actions among institutional development, incentives, ownership structure, and accounting
properties. Different from the findings reported by Ali et al. (2007) and Wang (2006) on
U.S. family firms, we find that such firms in China disclose less informative earnings, are
less conservative in their financial reporting, and are more likely to engage in the manipu-
lation of discretionary accruals. These findings are consistent with our argument that
Chinese family firms have greater Type II agency problems than their nonfamily
counterparts.
Several limitations must be acknowledged. This study does not examine the effect of
China’s convergence to International Financial Reporting Standards (IFRS), a process that
began in 1993. Following the country’s new generally accepted accounting principles
(GAAP), which became effective in 2007, it is clear that the Chinese authorities believe the
convergence between Chinese GAAP and IFRS to be nearly complete (Ding & Su, 2008,
p. 478). The findings of the current study suggest that incentives and institutions, perhaps
in combination with accounting standards and education, may have an impact on corporate
transparency. Our sample period ended before the new standards were implemented in
2007. A possible direction for future research would be to examine whether China’s staged
approach to IFRS convergence has any impact on the results reported here. The

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16 Journal of Accounting, Auditing & Finance

profitability requirement and valuation of IPOs have been dramatically changed over the
past 15 years, and corporate laws are increasingly well defined.9 Future research could also
examine the effect of these changes on our results. In addition, some of our results (such as
those of our discretionary accruals analysis) are marginally significant, and caution should
thus be exercised in their interpretation.

Authors’ Note
The authors are grateful for the helpful comments from the anonymous referee, Charles Chen, Yuan
Ding, Gordon Richardson, and seminar participants at the Peking University, Shanghai Jiaotong
University, and the 2009 Shanghai Winter Finance Conference of China. They also thank Qingbo
Yuan for his excellent research assistance. The usual disclaimer applies.

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/
or publication of this article.

Funding
The author(s) received no financial support for the research, authorship, and/or publication of this
article.
Notes
1. The authors investigate nonstate firms in this article and thus ‘‘nonfamily firms’’ refers to non-
state, nonfamily firms hereafter.
2. In untabulated analysis, the largest shareholders of family firms own about 35.5% of shares, and
the largest shareholders of nonfamily firms own about 36.2% of shares; the difference in owner-
ship concentration between family and nonfamily firms is insignificant.
3. Fan and Wong (2002) use only earnings informativeness, not the other two attributes.
4. The authors also run regressions using operating income rather than net income, and the results
are similar.
5. Speculative trading is an important factor that may affect the value of RET for firms in China. It
is well known that speculative trading, which tends to create outliers with exceptionally high- or
low-RET values, is rife in the Chinese stock markets. We tackle this problem by winsorizing
RET at the 10th and 90th percentiles.
6. The authors also tried Basu’s (1997) reverse regression approach. However, the relationship
between family ownership and timely loss recognition is nonsignificant even though the coeffi-
cient estimate has the expected sign. As Gigler and Hemmer (2001) argue, Basu’s approach may
generate biased results because it does not control for the potential effect of voluntary disclosures
on stock prices.
7. Including these firms in the analysis does not change our main results.
8. In China, a listed firm with losses may be designated as Special Treatment (ST) or Particular
Treatment (PT) firms by the regulatory body. ST/PT firms are usually subject to greater regula-
tory and market scrutiny.
9. The authors thank the anonymous referee for raising this point. In China, firms were required to
achieve an annual profitability level of at least 10% for three consecutive years to be qualified
for an IPO, but the criteria were changed later to 10%, on average, for three consecutive years.
Furthermore, the Chinese Corporate Law was enacted in 1993 and was amended 3 times in
1999, 2004, and 2005. It is believed that these amendments have led to significant improve-
ments. The latest Corporate Law, for instance, has codified independent directorship and

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Ding et al. 17

addressed serious constraints facing supervisory boards, which are part of the dual-board struc-
ture in Chinese listed companies.

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