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Journal of International Financial Management and Accounting 18:3 2007

Ownership Structure and Accounting Information Content: Evidence from France


Ronald Zhao
Department of Accounting, Monmouth University, West Long Branch, NJ 07764-1898 e-mail: rzhao@monmouth.edu

Benedicte Millet-Reyes
Department of Economics and Finance, Monmouth University, West Long Branch, NJ 07764-1898 e-mail: breyes@monmouth.edu

Abstract
This paper investigates how family and bank ownership aect the accounting information content of French rms. In Continental Europe, the existence of block-holders triggers specic corporate governance issues, including the transparency of nancial reporting. Our test results for the clean surplus model show that book value carries a signicantly greater weight for family-controlled rms. This nding 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 ndings that in code law countries, insiders dominate as a source of nance, and nancial reporting is aimed at creditor protection.

1. Introduction
The objective of nancial 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 dierences in levels of securities market development and environmental 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 while the code law (control)-based model dominates in continental Europe,
We want to thank the editor and an anonymous reviewer for their valuable comments.
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Japan, and in the emerging markets. The former is usually characterized by an independent board, disperse equity ownership, transparent disclosure, and active takeover markets, while the latter emphasizes an insider board, limited disclosure, and reliance on family/bank nance (La Porta et al., 1998). In market-based economies, shareholders are often viewed as monitors of the rm by virtue of the size of their stake. The accounting literature, based on the assumption of a close link between control rights and cash ow rights, has focused on agency problems related to the common law model. These issues include board composition, shareholder 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 ow 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 inuence occurs at the national and rm levels. In this environment, three main types of block-holders exercise signicant inuence in corporate governance: families, nancial institutions, and the state, which are major sources of capital for publicly traded rms. Government ownership can be found mostly in large corporations, while family ownership is predominant in smaller rms. 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 signicant control power in excess of their cash ow rights (La Porta et al., 1999). Also, corporate ownership structures become increasingly complex as a result of mergers, pyramids, and cross-border investment activities. In this context, the role of large shareholders as eective rm monitors has gained much research interest in recent years. However, there is limited evidence of their inuence on nancial reporting. This study investigates the impact of two types of blockholders, families, and banks, on the accounting information content of French rms. More specically, we explore whether ownership structure aects 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 nancial reporting in France. Section 3
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develops our theoretical foundations and three model hypotheses. Section 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 diered signicantly 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 capitalization compared with common law countries. Firms with closely controlled 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 (MilletReyes, 2000). Two main exchanges gather most of the listed rms: 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 rms to be traded on a continuous basis or by auction. In this context, large family ownership triggers specic corporate governance issues in French rms. The quality of information disclosure, the protection of minority shareholders and the independence of the board are three factors that can aect corporate performance and reporting mechanisms. However, evidence on family rms is limited because they are often too small to use public markets. Anderson and Reeb (2003) nd that one-third of the S&P 500 rms in the United States have some form of family ownership and that performance is enhanced when a family member 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 protection. Thomsen et al. (2006) use Granger tests to demonstrate that blockholder ownership leads to lower subsequent rm value and accounting protability 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 nd that a more equal
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distribution of votes among large shareholders can mitigate governance issues in family-controlled rms (Maury and Pajuste, 2005). There is more theoretical and empirical evidence on bank ownership. Shleifer and Vishny (1997) report a positive association between institutional ownership and rm 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 rms benet from their lending relationship with banks and from privileged access to capital markets. Therefore, banking relationships can mitigate the costs of external nancing and monitoring. However, critics argue that banks enlarge agency problems when they control access to external capital markets and issue loans to the rm (Wenger and Kaserer, 1998). Gordon and Schmid (2000) hypothesize that banks can aect rm performance in three ways. First, if there is a coincidence of interests between banks and other shareholders, they will exert a benign inuence and improve rm 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 rm performance and bank control may be downward sloping over some initial range of ownership and then upward sloping. Stock markets may react in a negative way to bank owners if perceived as protecting their xed 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, Plan Comptable General (PCG). The CNC is responsible for the establishment of a national accounting language acceptable to all parties using nancial 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 depreciation 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 nancial 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 nancial statements). The application of the PCG is exible in two major respects. First, rms can choose between the abridged, standard, or expanded version of accounts depending on their size and management preferences. While the abridged version is only applicable to enterprises below a specied size, all medium and large rms 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 specicities, provisions exist to adjust the PCG to the accounting needs of particular industries. There are two categories of adjustments: plans professionnels and plans de normalization comptable. One unique feature of PCG is that it also presents an exposition on management accounting, which is optional for all enterprises (Choi and Meek, 2005; Nobes and Parker, 2006). The PCG ts 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 dele) 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 classication leads to signicant dierences with common law countries where accounting information is a prerogative of enterprise management. Previous studies show mixed results on the accounting information content of nancial reports by French rms. According to Saudagaran and Biddle (1991) and Ball et al. (2000), nancial 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 rms compares favorably to that of US rms. In this paper, we investigate the role of accounting as a monitoring tool for corporate control. More specically, we test whether variations in the accounting information content of French rms may be attributed to the dierences
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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 aairs. These uses can be correlated to varying degrees. A rms reported earnings can be used to assess past performance and predict future cash ows, which in turn inuence security prices. Reported earnings are subject to revenue recognition policies and methods, the need to match revenues and expenses in certain time periods, and managerial judgment. These motivations may aect the quality of a rms 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 of reasons for earnings management, including inuencing the stock market, 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 earnings to deceive investors and creditors, thus constituting nancial statement fraud. Dechow and Skinner (2000) describe the distinction between conservative, neutral, aggressive, and fraudulent earnings management activities. The literature on code law countries reports that insiders have incentives to manage reported earnings in order to mask the rms true
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performance. Inside owners tend to conceal their private control benets from outsiders through income smoothing. This is because the politicization of accounting standards decreases the demand for timely reporting and increases the need for income smoothing (Ball et al., 2000). In this context, the quality of accounting income is inuenced 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 prole of earnings in order to reduce the uctuations 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 ows 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 rms long-term cost of capital. Banks are subject to wide uctuations in investments values and period losses on lending, which can be disproportionate to single-year prots. Consequently, bank management is known to have strong incentives for income smoothing and earnings stability, which would lead to a benecial eect 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 rms in France. In contrast, it is dicult to specify ex ante, which techniques family-owned rms may use to report rm performance as public nancial statements by 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 dierences in accounting information content between bank- and family-owned rms 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 scal year change in the
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book value of equity adjusted for dividends and capital contributions. The sum of the rms lifetime accounting income and its lifetime economic income are identical. Therefore, the valuation of a rm consists of its book value of equity, its current protability as measured by earnings and other information items aecting the prediction of future protability. According to prior studies, family ownership tends to be more dominant than bank ownership in France, thus having a crowdingout eect on outside investors. As a result, bank-owned rms may have a greater number of outside (minority) shareholders. Also, bank owners will be more likely to inuence 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 rst hypothesis is: H1: Ceteris paribus, earnings (book value) carries a greater weight for bank-owned (family-owned) rms in France. An expanded clean surplus model can be utilized to test the rst hypothesis: Pit a b1 BVit b2 Eit b3 Oit b4 BVit Oi b5 Eit Oi ei where Pit BVit Eit Oi BVit Oi Eit Oi ei 1

is the rm is stock price at the end of year t is the rm is book value of common equity per share for year t is the rm is reported earnings per share for year t is the ownership percentage (bank and/or family) is an interaction term between BVi and Oit is an interaction term between Ei and Oit is a disturbance term

We test H1 on three ownership characteristics measured by the variable Oi. In the rst 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 rms ownership structure. We hypothesize that family-controlled rms have less incentives than banks to provide full disclosure of current-period income because accounting is costly, 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 rms under dierent 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 reects 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 rm be considered as a contractual arrangement with two distinct groups of stakeholders, one of whom benets from the eects of earnings management at the expense of the other. The mechanism for assigning the benet is often based on the accounting price of some claims or resources. To the extent that insiders dier in their incentives for asset diversion, they would try to control the preparation and dissemination of nancial information in dierent 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 rm, which gives them privileged access to inside information. Their roles have signicant implications for capital structure and earnings quality, thus aecting the accounting information content of the rms balance sheet and income statement. We expect that the addition of bank ownership to family-owned rms would shift the weight from book value to reported earnings for rms with joint family/bank ownership. This would reect 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 ow 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 ow or income recognition. This is done in order to drive down (up) cash ow/income in good (bad) years. The eectiveness of accounting accruals in ameliorating serial correlation in operating cash ow is a fundamental feature of the accounting model of income determination (Dechow, 1994). In general, operating cash ow
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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 ows. The residual noise is independent of economic income and reduces the timeliness of accounting income. In our second hypothesis, we test whether the higher earnings persistence (quality) of bank-owned rms conforms to the income-determination model. H2: Ceteris paribus, bank ownership has a greater impact on the operating cash ow and accounting accrual components of French rms than does family ownership. This hypothesis can be tested by dividing earnings into its operating cash ow and accounting accrual components in the expanded clean surplus-accounting model Pit a b1 BVit b2 CFit b3 ACit b4 Oi b5 BVit Oi b6 CFit Oi b7 ACit Oi eI 2 where CFit ACit is the operating cash ow per share of rm i for year t is the accrual per share of rm i for year t.

All other variables are as previously dened. In this second model, b6 and b7 are expected to have opposite signs because accounting accruals are used to remove the negative serial correlation in operating cash ow (noise) from current-period income. Also, b6 and b7 should dier signicantly 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 ow component should be more (less) noisy, and accounting accruals less (more) signicant in the reported income of family (bank)-owned rms, 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 reecting the relative information content of operating cash ow 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 information from the rms 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 rms 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 dierent ownership characteristics. Based on the existing literature, we hypothesize that rms with bank owners are more likely to have broader and/or cheaper access to long-term debt (Trueman et al., 1988) than familyowned rms . H3: Ceteris paribus, ownership structure creates signicant dierences 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 LDit Oi b6 EQit Oi b7 RESit Oi ei where MVit LDit EQit RESit is is is is total market value of rm i at the end of year t the long-term debt of rm i at the end of year t the total shareholders equity of rm i at the end of year t the total capital reserve of rm i at the end of year t

All variables, except for Oi (ownership percentage), are deated by the square root of total assets. The interaction terms are as dened in the previous model. Families and banks should have a signicant inuence on nancing and investing decisions because they are debt and equity providers. b1 reects the markets response to long-term debt nancing and should be negative as net assets decrease with debt. The interaction term for debt and ownership, b5, measures the response to agency conicts between debt and equity holders. A negative (positive) sign implies that markets react negatively (positively) to debt held by family (bank) rms. b6 and b7 measure the respective signicance of the two components of equity (Equity and Reserves) in the capital structure of rms under dierent 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 rms to denote its lack of value relevance.

4. Data Description
The sample consists of 661 rm-year observations in a pooled sample, covering 206 French non-nancial rms over the period 19941998. All rms are medium-sized corporations traded on the Second Market. They are now included in Euronext Paris (created in 2000) and have the same listing requirements as rms belonging to the First Market. In the late 1990s, three main trading categories were used on the Second Market. The more-liquid rms were traded in two continuous categories (Continu A or Continu B) while the less-liquid rms 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 nanciers, 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 rms 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 rms in

Table 1a. Ownership Statistics Variable


N Family (%) Mean Median Bank (%) Mean Median
n

All rms
661 42.75 51.20 3.91 0

Family 50%
314 14.14n 0n 4.89n 0n

Family 450%
347 68.64n 66.4n 3.04n 0n

Bank 5 0%
422 46.83n 55.0n 0n 0n

Bank 40%
239 35.55n 46.3n 10.83n 6.7n

T-tests or non-parametric test indicate statistical signicance at the 5% level.

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Table 1b. Financial Statistics

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Variable All rms Family 50% Family450% Bank 5 0% Bank40%


MV Mean Median BV Mean Median EPS Mean Median LT Debt Mean Median Equity Mean Median Reserves Mean Median Op. CF Mean Median Accrual Mean Median Op. CF/NI Mean Median Var EPS Mean Median
n nn

45.38 33.47 209.53 149.85 14.93 13.91 177.29 139.70 321.87 247.69 31.32 17.73 71.91 51.43 32.93 21.76 3.61 2.85 1.58 0.39

47.92 40.25n 226.71n 158.08n 16.78 15.70n 173.36 129.85nn 364.24n 283.85n 37.88n 20.96n 73.78 52.27 33.44 20.39 3.29 2.71n 1.44 0.35nn

43.09 30.37n 193.99n 144.38n 13.26 12.72n 180.85 145.38nn 283.53n 224.14n 25.38n 14.16n 70.22 50.26 32.46 23.08 3.90 3.03n 1.70 0.46nn

44.33 33.34 196.32n 134.18n 15.40 13.35 165.65n 129.08n 309.28nn 229.29n 29.61 13.89n 70.98 44.65n 32.24 18.61n 3.75 2.81 1.86nn 0.39

47.24 34.85 232.86n 173.0n 14.11 15.76 197.85n 155.24n 344.11nn 283.12n 34.34 23.16n 73.55 57.05n 34.14 24.33n 3.35 2.99 1.09nn 0.41

T-tests or non-parametric test indicate statistical signicance at the 5% level. T-tests and non-parametric tests indicate statistical signicance at the 10% level. MV, market value; BV, book value; EPS, earnings per share; Op. CF, earnings before interest and taxes plus Accrual where Accrual is measured as depreciation expense plus accruals.

France are controlled at the 20 per cent level by families. Despite their relatively small ownership percentage, banks can nevertheless exercise eective monitoring. They can control the proxy votes of small shareholders and put voting restrictions on the votes of non-bank blockholders. Table 1b provides nancial statistics based on the ownership categories constructed in Table 1a. The variable denition for Table 1b is as follows: 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
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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 rst split is 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 rms 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 rms have larger book values and higher levels of longterm 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 ow and net income. The rst one is calculated as the ratio of operating cash ow divided by net income (Op.CF/NI). The descriptive results show that family-controlled rms maintain a smaller gap between reported earnings and operating cash ow. The second variable (var EPS) is the absolute value of the percentage change in EPS between years t and t 1. This ratio is larger for family-controlled companies and smaller for rms with bank ownership. Also, accruals are statistically higher (based on non-parametric tests) for companies with bank shareholders. These results show that rms with large family shareholders generate less earnings persistence than bank-owned rms. 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 for family 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 rms with family ownership >50 per cent). A comparison of the three sets of results shows the signicant impact of family versus bank ownership on the accounting information content of French rms. We added stock market liquidity and industry dummies in all models to
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control for company and industry dierences. These coecients are omitted in the result tables.

5.1. Model 1: Earnings Quality and Ownership Characteristics


Table 2 reports the regression results of the rst model. The model attains a signicance 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 t 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 signicantly 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 scal law. French scal law has imposed control upon the construction 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-ofperiod adjustments, therefore having a major impact on the nal annual accounts and estimated taxable income. In contrast, the signicantly negative interaction with bank ownership is accompanied by a corresponding signicantly positive interaction between reported earnings and bank ownership (b5). This represents a transfer of weight from the book value to reported earnings through the linear information dynamic between the two items. While b5 has a signicantly positive coecient for bank ownership, it is signicantly negative for family ownership. As family-owned rms depend less on outside equity capital, there is correspondingly less demand for transparency and timeliness in their reported earnings. Their signicantly negative b5 suggests that family ownership reduces the information content of current reported earnings. The signicantly positive coecient 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
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Table 2. Regression Results for Model 1 Bank t-statistic


6.49 4.00nnn 5.42nnn 1.03 3.85nnn 2.58nnn
nnn nnn

Family Coecient
66.529 0.095 0.197 0.069 0.001 0.025 661 25.50 o.0001 0.4136 6.57 11.56nnn 4.57nnn 0.28 2.13nn 3.97nnn

Family/Bank t-statistic Coecient


68.654 0.125 0.112 0.782 0.005 0.103 347 16.02 o.0001 0.4520

Ownership

Coecient

t-statistic
2.85nnn 9.37nnn 2.09nn 1.39 3.20nnn 5.05nnn

Ronald Zhao and Benedicte Millet-Reyes

Intercept BV E O BV O EO

66.661 0.051 0.441 0.061 0.001 0.004

N F-value Pr4F Adjusted R2

661 25.67 o.0001 0.4152

Signicant at the .1 level. Signicant at the .05 level. nnn Signicant at the .01 level. BV, book value of common equity per share. E, reported earnings per share. O, percentage of ownership.

nn

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information dynamic between the two items in the clean surplusaccounting framework. The third set of tests measures the impact of joint family/bank ownership. The results are dierent from those of family ownership alone (rst test), but similar 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 signicantly negative (positive) sign. The shift in the weight from book value to reported earnings results in a better t of the clean surplusaccounting model for rms with joint family/bank. These results indicate that the addition of bank ownership to family-dominated rms is responsible for a signicant improvement in the accounting information content of both book value and reported earnings. This suggests that banks provide an eective monitoring role for nancial 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 signicantly dierent for rms 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 the link between ownership structure and the value relevance of operating cash ow and accounting accruals in reported earnings. The coecients of book value (b1), operating cash ow (b2), and accounting accruals (b3) all have the expected signs. The positively signicant coecient of operating cash ow with the three ownership categories indicates its high value relevance as a major component of accounting earnings. The negatively signicant coecient of accounting accruals in all three groups reects its osetting role in removing the noise from operating cash ow (Dechow, 1994). In the family ownership tests, the coecient of the interaction term (b5) with book value is signicantly positive, which is consistent with the test results of H1. Neither b6 nor b7 is signicant, suggesting that both components of accounting earnings lack value relevance for family-owned rms. The test results for bank ownership show a signicantly positive coecient for the interaction term with operating cash ow (b6), and a negative but insignicant coecient for the interaction term with accounting accruals (b7). The ndings of Model 2 indicate that bank ownership achieves higher earnings quality primarily through a higher quality of operating cash ow.
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Table 3. Regression Results of Model 2 Bank t-statistic


6.70 2.05nn 7.98nnn 6.93nnn 1.43 3.82nnn 1.58 0.54
nnn nnn

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Family Coecient
63.691 0.084 0.418 0.692 0.177 0.001 0.009 0.003 661 29.71 o.0001 0.4774 6.63 7.38nnn 9.54nnn 9.06nnn 0.67 1.66nn 1.66nn 0.45

Family/bank t-statistic Coecient


73.991 0.109 0.341 0.605 1.094 0.011 0.021 0.096 347 17.87 o.0001 0.5058

Ownership

Coecient

t-statistic
3.22nnn 5.66nnn 5.25nnn 4.78nnn 1.87nn 3.34nnn 1.97nnn 3.95nnn

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Intercept BV CF AC O BV O CF O AC O

64.337 0.032 0.539 0.799 0.079 0.001 0.002 0.001

N F-value Pr4F Adjusted R2

661 31.51 o.0001 0.4926

Signicant at the .1 level. Signicant at the .05 level. nnn Signicant at the .01 level. BV, book value. CF, operating cash ow per share. AC, accrual per share. O, ownership percentage.

nn

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The results for joint family/bank ownership are also signicant. There is a positive interaction with book value (b5), as well as a statistically signicant positive interaction with operating cash ow (b6). The negative and signicant interaction with accounting accruals (b7) emphasizes the tension between bank and family owners in terms of income determination. These results suggest that bank ownership mitigates the negative eect of family control on earnings quality by removing the noise in operating cash ow. This is carried out through a signicant 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 rms rely more on real earnings smoothing, which is accomplished by timing investment or nancing 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 smoothing reduces the susceptibility of accounting accruals to earnings manipulation. 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 reported earnings 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 rst category show that family ownership has a signicant impact on the accounting information content of the three capital structure components: Equity, Reserves and Debt. The interaction term of family ownership with long-term debt (b5) is signicantly negative. This result shows that markets assign a higher cost to the debt nancing of familyr Blackwell Publishing Ltd. 2007.

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Table 4. Regression Results of Model 3 Bank t-statistic


16.47 1.90nn 4.56nnn 1.27 3.07nnn 3.48nnn 7.19nnn 3.86nnn
nnn nnn

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Family Coecient
421.419 0.156 0.191 0.287 1.134 0.001 0.004 0.019 661 36.92 o.0001 0.5333 13.30 5.64nnn 10.13nnn 2.79nnn 1.22 0.52 2.41nnn 1.34

Family/Bank t-statistic Coecient


250.773 0.196 0.293 0.558 2.080 0.002 0.007 0.091 347 18.41 o .0001 0.5138

Ownership

Coecient

t-statistic
3.77nnn 4.64nnn 8.00nnn 3.11nnn 0.96 0.35 2.52nnn 3.17nnn

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Intercept LD EQ RES O LD O EQ O RES O

583.876 0.063 0.097 0.164 0.560 0.002 0.003 0.011

N F-value Pr4F Adjusted R2

661 48.92 o .0001 0.6039

Signicant at the .1 level. Signicant at the .05 level. nnn Signicant at the .01 level. LD, long term debt. EQ, total shareholders equity. RES, capital reserves. O, ownership percentage.

nn

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owned rms. In contrast, the interaction term of bank ownership with long-term debt (b5) is positive (although insignicant), suggesting that bank ownership mitigates the agency cost of debt. These results conrm 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 rms with bank owners is also veried by the nancial statistics of Table 1b. The signicantly positive coecients 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 signicantly positive, b7 is insignicantly 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 dierence between bank and joint family/bank ownership is that b7 is negative and insignicant (signicant) for bank (joint family/bank) ownership. This may be explained by the need to remove a higher level of noise in operating cash ow through equity reserves. These results are consistent with the ndings of Meek and Thomas (2004) showing that in code law countries, banks dominate as a source of nance and that nancial 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 diers 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 identied between the operating cash ow and accounting accruals components of accounting income. This demonstrates that the use of accounting accruals can provide economic information by removing negative serial correlation in operating cash ow. This process leads to higher earnings quality. Third, while bank
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owners use of accounting accruals increases the information content of reported earnings, it also decreases the signicance of equity reserves as a conduit for accounting accruals. Fourth, our empirical evidence suggests that markets perceive family-controlled rms as more likely to have increased agency costs when using long-term debt. In summary, our ndings 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 signicantly associated with family (bank) ownership. Last, we investigate whether our test results may be inuenced by rm size. Our sample shows a signicant dierence in the mean of book value and equity between rm with and without family (bank) ownership (Table 1b: Financial Statistics). However, our regression analysis controlled for size in several ways. First, we used variables measured per share in Models 1 and 2, and deated 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 coecients were statistically signicant 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
Dierences in accounting standards, corporate governance and disclosure practices lead to signicant discrepancies in the usefulness of accounting information across countries. This study focuses on the impact of ownership structure on the accounting information content of book value and reported earnings in France. Our sample includes medium-sized French rms with family, bank and/or joint family/bank ownership. The market responds dierently to the information content of nancial reporting based on ownership structure. Test results provide evidence that book value carries a signicantly greater weight in the clean surplus-accounting equation and therefore weakens the linear information dynamics for family-controlled rms. In contrast, bank-owned rms report highly persistent earnings through the use of accruals. They also benet 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 accounting model, French rms exhibit signicant in-group variances with regard to nancial reporting objectives and practice due to dierent ownership structures. According to the agency theory, both families and banks maximize their own expected utilities and are resourceful in doing so. We see less conict of interests with outside investors when rms include banks as shareholders. This suggests that a more equal distribution of control rights among large shareholders can mitigate these issues, especially in family-controlled rms. Bank ownership also leads to higher earnings quality and mitigates the agency conicts generated by debt nancing.

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