THE 10th ISLAMIC BANKING, ACCOUNTING AND FINANCE INTERNATIONAL CONFERENCE 2022
(iBAF 2022)
The Impact of Blockholder Ownership and Largest Shareholder Ownership on Real and Accrual-based Earnings Management: Evidence from Jordan
Rami Najeeb Mohammad Alzu’bi
Faculty of Economics and Muamalat, Universiti Sains Islam Malaysia (USIM), Bandar Baru Nilai, 71800 Nilai, Negeri Sembilan Malaysia
Tel: +60 14 265 2825 E-mail: [email protected]
Nathasa Mazna Ramli
Faculty of Economics and Muamalat, Universiti Sains Islam Malaysia (USIM), Bandar Baru Nilai, 71800 Nilai, Negeri Sembilan Malaysia
Tel: +606 798 6408 E-mail: [email protected]
Abstract
This paper examines the impact of blockholder and largest shareholder ownership on real and accrual-based earnings management in manufacturing companies listed on the Amman Stock Exchange (ASE). The sample is 38 industrial companies listed on the ASE in 2015-2019. The impact of blockholder and largest shareholder’s ownership on real and accrual-based earnings management is estimated using regression analysis. The results indicate that blockholder ownership of between 5%
and 25% has a statistically significant positive impact on both accrual-based and real earnings management at the 5% level of significance. Similarly, blockholder ownership of between 25.1% and 50% has a statistically significant positive impact on both accrual-based and real earnings management at the 5% level of significance. Blockholder ownership of over 50.1% has no statistically significant impact on both accrual-based and real earnings management at the 5% level of significance. Largest shareholder ownership has a statistically significant positive impact on both real earnings management and accrual-based earnings management. Finally, firm size has a statistically positive impact on REM but not on AEM.
Keywords: Real earnings management; accrual-based earnings management; blockholder ownership; largest shareholder’s ownership
1. Introduction
Blockholders are an internal monitoring mechanism that are considered as effective observers of the performance of managers. They can interfere in the work of management either by voice or by way of exit (Amin and Cumming, 2021). Putri and Lusy (2021) define blockholders as owners whose shares exceed 5% of the total and who are not members of the controlling family.
Cost control is one of the ways to reduce conflicts of interest between shareholders and managers. While shareholders bear the costs of monitoring and supervising the managers, their power to control is proportional to their ownership percentage. Therefore, minority shareholders will have little incentive and power to monitor and supervise the managers (Daryaei and Fattahi, 2020). On the other hand, larger shareholders have the incentive and ability to monitor and supervise the management (El Moslemany and Nathan, 2019).
Agency theory explains the contractual relationship between two groups whose goals are at odds: the principals (owners) and agents (managers). From this relationship spring various problems. First, conflict of interest. Both the principal and the agent are characterized by rational behavior, which means that each works to achieve the most of their respective expected benefits. For the owners (principals), the expected benefit is to increase their wealth and accomplish their individual interests in the form of financial returns from their investment in the company (Vitolla et al., 2020). As for the agents (managers), their expected return is the rewards that they will receive from the company. This is their motives for carrying out their responsibilities. If there is no return, they would prefer not to make an effort even if this decision affects the interests of the owners and shareholders.
Jensen and Meckling (1976), Shleifer and Vishny (1986), and Dechow et al. (1995) agree that blockholders are effective observers of corporate governance. If they are given the incentive, they will monitor the performance
of managers. Since they have the strength and capacity, they will improve the reliability of financial reporting, reducing earnings management.
Blockholder ownership is based on the idea of controlling the behavior of managers and minimizing significant interference in financial reports. Many studies have discussed the relationship between blockholders and earnings management, though the results have been inconclusive. Reyna (2018) and Putri and Lusy (2021) show that blockholders do not influence earnings management, whereas Amin and Cumming (2021) and El Moslemany and Nathan (2019) find a positive relationship between external blockholder ownership and earnings management.
Alzoubi (2016) and Lassoued et al. (2015) reveal that the relationship between blockholder ownership and earnings management is negative.
Thus, this study examines the effect of blockholders and largest shareholders on real and accrual-based earnings management in industrial companies listed on the Amman Stock Exchange (ASE). Thus, the research problem can be expressed with this question: Do blockholders affect real and accrual-based earnings management in industrial companies listed on the ASE?”
2. Literature review and hypotheses development
Jensen and Meckling (1976) agree that blockholders are effective monitors of management and can thus reduce agency costs. Compared to small shareholders, blockholders have more incentives to monitor management’s performance. Small shareholders can easily divest if the company’s performance does not meet their expectations.
In contrast, blockholders cannot readily sell their shares as this would cause the company’s share price to drop, and as such they have to adopt a long-term strategy in their investments, which encompass, among others, effective monitoring (Ibrahimy et al., 2019). Fattoum-Guedri et al. (2018) also suggest that blockholders can reduce the agency problem by reducing accounting fraud because they control the reporting process and pay managers to work for the company and the shareholders.
Blockholders refer to shareholders with controlling rights, as they are owners who hold more than 5% of total shares. This ratio is similar to the large shareholders, which gives them the ability to mitigate earnings management and agency conflict between large and minority shareholders. Given that shareholders are not homogeneous in terms of their incentives and strength, this study examines the effects of blockholders and largest shareholders on real and accrual-based earnings management.
An opposing view however posits the positive relationship between blockholders and earnings management.
Because they are investing for the long-term, they have a vested interest in the positive image and financial performance of their investments. To ensure that these are accomplished, they often interfere in business decisions and puts pressure on the managers. The managers, in turn, would be compelled at times to resort to earnings management to realize these interests (Ibrahimy et al., 2019).
Empirical studies have shown the effectiveness of blockholders to limit earnings management. Ilmas et al.
(2018) find that blockholders are negatively associated with earnings management. Alzoubi (2016) reveals that blockholders have a positive influence on financial reporting quality and can potentially curtail earnings management. Conversely, Shleifer and Vishny (1986) and Barclay and Holderness (1991) conclude that outside blockholders can pressure managers to manage earnings so as to increase income.
H1: Blockholders ownership has no impact on real earnings management in industrial companies listed on the ASE.
H2: Blockholders ownership has no impact on accrual-based earnings management in industrial companies listed on the ASE.
H3: Largest ownership has no impact on real earnings management in industrial companies listed on the ASE.
H4: Largest ownership has no impact on accrual-based earnings management in industrial companies listed on the ASE.
3. Data
The sample consists of all listed industrial companies in 2015-2019 whose data are available. The final sample is 38 out of 42 firms listed on the ASE in 2020 (ASE, 2020). The manufacturing sector is chosen because of its importance for the Jordanian economy, as it contributes to about 25% of the national GDP. Data for the research variables are collected from the annual reports of the sample during 2015-2019. Four companies are excluded because of the lack of data in their reports.
The dependent variables in this study are real and accrual-based earning management. Real earnings management is measured using Roychowdhury’s (2006) model, while accrual-based earnings management is measured using Kothari et al.’s (2005) model.
The independent variable of blockholder ownership is divided into three blocks. Block 1 equals 1 if the blockholder owns equal to or more than 50.1% of the company’s share and 0 otherwise. Block 2 equals 1 if the
blockholder owns between 25.1% and 50% of the company’s share and 0 otherwise. Block 3 equals 1 if the blockholder owns between 5% and 25% of the company’s share and 0 otherwise. Meanwhile, the largest shareholder is the percentage held by the largest shareholder (Moshirian et al., 2014). Firm size is included as a control variable. It is the natural logarithm of total assets (Al-Fayoumi et al., 2010). The following two regression models are used to examine the relationships:
AEM it = α0 + β1 BLOCK1 it + β2 BLOCK2 it + β3 BLOCK3 it + β4 LARGEST it + β5 FIRMSIZE it + Ɛ (1) REM it = α0 + β1 BLOCK1 it + β2 BLOCK2 it + β3 BLOCK3 it + β4 LARGEST it + β5 FIRMSIZE it + Ɛ (2) where AEM: accrual-based earnings management; REM: real earnings management; BLOCK1: blockholders owning 50.1% or more shares; BLOCK2: blockholders owning more than 25.1% to less than 50% of shares;
BLOCK3: blockholders owning between 5% and 25% of shares; LARGEST: the percentage of shares held by the largest shareholder; and FIRMSIZE: the natural logarithm of total assets.
4. Results
4.1. Descriptive statistics
Table 1 presents the descriptive statistics (maximum, minimum, mean, and standard deviation) of the independent and dependent variables, using data from 170 firm-year observations of industrial companies listed on the ASE in 2015-2019. This study uses Roychowdhury’s (2006) model to measure real earnings management and Kothari et al.’s (2005) model to measure accrual-based earnings management.
Table 1. Descriptive statistics.
Variable Minimum Maximum Mean Std. Deviation
Accrual-based earnings management -0.34 0.22 0.0001 0.08100
Real earnings management 0.09 2.59 0.6452 0.37435
Largest shareholders 0.31 0.74 0.4900 0.03827
Firm size 8.00 10.69 9.3455 0.4820
The results in Table 1 show a low level of accrual-based earnings management (M = 0.0001, max = 0.22, min
= -0.34), consistent with Alzoubi (2016) and Ballesta and Meca (2007). On the other hand, there is a high level of real earnings management (M = 0.6452, max = 2.59, min = 0.09), consistent with Idris (2012).
On average, about 49% of ownership of industrial companies in Jordan is concentrated in the hands of a single person or entity (M = 0.490, max = 0.74, min = 0.31). In this case, the largest shareholder is the Social Security Corporation. This result is consistent with Idris (2012). Firm size varies between companies (M = 9.3455, max = 10.69, min = 8.00). The firm size variable is transformed into natural logarithm to resolve standard deviation and normality problems. The result is consistent with Idris (2012).
4.2. Frequencies
Frequencies are used to examine the distribution of the dummy variable (Table 2).
Table 2. Frequency statistics.
Variable Frequency Percentage
Blockholders between 5% -25% 133 78.2
Blockholders between 25.1% - 50% 19 11.2
Blockholders above 50.1% 18 10.6
The results in Table 2 show that there are 133 firm-year observations (78.2% of the sample) for blockholders owning between 5% and 25% of shares. This means that most blockholders own 5% to 25% shares. There are only 19 firm-year observations (11.2%) for blockholders with 25.1%-50% of shares. Finally, there are only 18 firm-year observations (10.6%) for blockholders with more than 50.1% of shares.
4.3. Accrual-based and real earnings management
To test the effects of blockholder ownership and largest shareholders on real and accrual-based earnings management, the OLS model is used to estimate discretionary accruals using Kothari et al.’s (2005) model and to estimate REM using Roychowdhury’s (2006) model. The results are as follows.
4.3.1. Accrual-based earnings management
To estimate accrual-based earnings management, Kothari et al.’s (2005) model is used. Table 3 shows the results of the estimation.
Table 3. Accrual-based earnings management model (Kothari’s model).
B T Sig
(Constant) -0.094 -0.960 0.346
1/Ai,t-1 0.349 0.477 0.607
(ΔREVi,t - ΔRECi,t) / Ai,t-1 0.003 3.262 0.003
PPEi,t / Ai,t-1 -0.017 -0.491 0.598
ROAi,t-1 0.005 6.288 0.000
R2 0.2467
F 13.104
Sig 0.000
D-W 2.047
The R2 is 24.67%, which means that there is a low level of accrual-based earnings management in Jordanian listed manufacturing companies. This regression equation is used to estimate accrual-based earnings management.
The results of the regression analysis are shown in Table 4.
Table 4. Blockholder ownership and accrual-based earnings management.
B T Sig
(Constant) -0.013 -1.840 0.068
Blockholders between 5% - 25% 0.063 3.197 0.002
Blockholders between 25.1%- 50% 0.053 2.646 0.009
Blockholders above 50.1% 0.021 1.043 0.298
Largest shareholders 0.063 2.092 0.038
Firm size -0.027 -0.727 0.468
R2 0.435
F 13.020
Sig 0.000
D-W 2.069
As shown in Table 5, the R2 of the model is 43.5%, which means that the blockholder and largest shareholder ownership variables explain 43.5% of the variance in accrual-based earnings management. Moreover, the model is significant (F = 13.020, p = 0.000), indicating that the model significantly explains the changes in accrual-based earnings management.
The results also indicate that blockholders with 5%-25% of shares have a significant positive impact on accrual-based earnings management (t = 3.197, p = .002). Blockholders with 25.1%-50% of shares also have a significant positive impact on accrual-based earnings management (t = 2.646, p = .009). These results are not as predicted, and they imply that low and moderate levels of block ownership could increase accrual-based earnings management practices. The results also suggest that blockholder ownership of over 50.1% has no significant impact on accrual-based earnings management (t = 1.043, p = .298). This result is not as predicted and implies that a high level of blockholder ownership do not influence accrual-based earnings management practices. On the other hand, largest shareholder ownership has a significant positive impact on accrual-based earnings management (t = 2.092, p = .038). This result is not as predicted and implies that high ownership concentration can increase accrual-based earnings management. Finally, firm size has no significant impact on accrual-based earnings management (t = -0.727, p = .468).
4.3.2. Real earnings management
Roychowdhury’s (2008) model is used to estimate real earnings management. Table 5 shows the results of the model.
Table 5. Real earnings management model (Roychowdhury’s model).
Sales manpulation Reduction of discretionary expenses Overproduction
B T Sig B T Sig B T Sig
(Constant) 0.370 3.489 0.001 -0.120 -1.485 0.157 -0.345 -2.518 0.019
1/Ai,t-1 -2.419 -3.024 0.005 1.330 2.197 0.039 2.327 2.273 0.033
SALESi,t/Ai,t-1 0.223 2.312 0.031 0.053 4.048 0.000 0.820 14.082 0.000
ΔSALESi,t/ Ai,t-1 -0.003 -2.338 0.029 - - - 0.004 1.597 0.129
ΔSALESi,t-1/ Ai,t-1 - - - - - - 0.096 1.586 0.132
R2 0.121 0.136 92.8
F 7.397 12.699 484.286
Sig 0 0 0
D-W 1.846 1.868 1.953
From Table 5, the adjusted R2 for sales manipulation and discretionary expenses are 12.1% and 13.6%.
Although they are higher than the figures reported by Kang and Kim (2012) (4% and 2% respectively), they are lower than those reported by Roychowdhury (2006) (45% and 38% respectively). On the other hand, the adjusted
R2 of overproduction is 92.8%, which is also similar to that of Roychowdhury (2006) (89%) and Kang and Kim (2012) (90%). The results of regression analysis are shown in Table 6.
Table 6. Blockholder ownership and real earnings management.
B T Sig
(Constant) -0.017 -1.514 0.132
Blockholders between 5% - 25% 0.054 3.382 0.001
Blockholders between 25.1%- 50% 0.062 4.892 0.000
Blockholders above 50.1% 0.014 0.979 0.329
Largest shareholders 0.063 5.170 0.000
Firm size 0.041 2.330 0.021
R2 0.544
F 15.394
Sig 0.000
D-W 2.088
As shown in Table 6, the R2 of the model is 54.4%, which means that blockholder and largest shareholder ownership variables explain 54.4% of the variance in real earnings management. Moreover, the model is significant (F = 15.394, p = 0.000), indicating that the model significantly explains the changes in real earnings management.
The results also indicate that blockholders owning between 5% and 25% (t = 3.382, p = 0.001) and between 25.1% and 50% of shares (t = 4.892, p = 0.000) have a significant positive on real earnings management. These results are not as predicted and suggest that low and moderate levels of blockholder ownership could increase real earnings management. Blockholders with over 50.1% have no significant effect on real earnings management (t
= 0.979, p = .329). This result is not as predicted and implies that a high level of blockholder ownership do not influence real earnings management. On the other hand, largest shareholder ownership has a significant positive effect on real earnings management (t = 5.170, p = .000). This result is not as predicted and implies that the largest shareholder could increase real earnings management. Finally, firm size has a significant positive impact on accrual-based earnings management (t = 2.330, p = .021).
5. Conclusion
The main objective of the study is to investigate the impact of blockholders and largest shareholder ownership on real and accrual-based earnings management in manufacturing companies listed on the ASE. The current research applies two models (accrual-based earning management and real-based earning management).
The results of the first model (accrual-based earnings management) show that blockholders with 5%-25% and with 25.1%-50% of shares have a statistically significant positive impact on accrual-based earnings management at the 5% level of significance. For the second model (real earnings management), the results show that blockholders owning between 5% and 25% and between 25.1% and 50% of shares have a statistically significant positive impact on real earnings management at the 5% level of significance. On the other hand, blockholders owning more than 50.1% of shares have no statistically significant impact on both accrual-based and real earnings management at the 5% level of significance.
The findings of the study may be useful for Jordanian regulatory bodies to enhance the effectiveness of corporate governance mechanisms. Furthermore, it may bring the attentions of practitioners (investors, bankers, etc.) in the manufacturing companies to give more consideration on the role of the board of directors in the quality of financial reports. A high-quality financial report can assist investors and bankers to make their investment and financing decisions. The results are also useful for the regulators in any improvement process of the corporate governance in Jordan.
The limitation of this research is that it includes only three characteristics of the board of directors. Future research may extend this work by including more board characteristics or other corporate governance characteristics. Future research could also include more control variables, such as performance and audit quality.
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