Auditor Choice, Earnings Management, and Performance of Chinese Listed Family Firms:The Impact of Political Connection

Abstract

Political influence in the private sector has become increasingly significant in the prevailing debate. Despite the rise of family conglomerates worldwide, the impact of political connection on family firms is still underexplored in the literature. In China, political connection is crucial for the survival and development of family firms. This work aims to fill the gap and examine how connections with various levels of government affect family firms’ accounting practices (i.e., choice of auditor and earnings management) and performance.

Employing the resource dependency theory, I argue that controlling families and managers are motivated to develop political connection to access valuable economic and social assets and consequently build up comparative advantage. However, the family firms may also experience serious agency conflicts arising from both concentrated ownership structure and political connection, which have substantial implications on their choice of auditors, financial reporting quality and firm performance.

Connection with government is beneficial to mitigate political and social discrimination, but simultaneously may turn those firms into the agents in pursuit of political interest. Then the incentive of the politicians is vital to shape the behaviour and performance of family firms. In fact, politicians at different hierarchical levels (i.e., central and local) have diverse priorities and objectives. The unique setup of central control and regional autonomy in the Chinese institutional environment provide a perfect context to explore the differential impacts of political connection at various levels of government on family firms. The findings show that locally connected family firms are more likely to appoint small auditors when the CEO also take the board chairman role, manage earnings through accrual-based and real activities, and have reduced performance than those connect with central government. Such effects are robust using alternative measure and models.