The Quality of Internal Control over Financial Reporting in Family Firms

TLDR

Family firms represent a majority of businesses worldwide and play a crucial role in the socio‑economic development of both developed countries and emerging economies. The study examines how family firm characteristics relate to internal control quality compared to non‑family firms and adds insight into mechanisms by which family firms may exert undue influence. The authors analyze a large sample of S&P 500 firms to assess internal control quality. Family firms exhibit more material weaknesses than non‑family firms, especially those with dual‑class shares, supporting the entrenchment argument that family owners favor weaker controls to extract private benefits.

Abstract

SYNOPSIS Family firms represent a majority of businesses worldwide, and play a crucial role in the socio-economic development of both developed countries and emerging economies. We study the relationship between family firm characteristics and the quality of internal control over financial reporting, relative to non-family firms. Using a relatively large sample of S&P 500 firms, we report that family firms exhibit more material weaknesses in their internal control over financial reporting than non-family firms. Further investigation suggests that the greater likelihood of material weaknesses is driven by family firms with dual-class shares. Our results are consistent with the entrenchment argument that family owners are motivated to maintain weaker internal controls in order to extract private benefits. Our study contributes to the extant literature on family firms by providing further insight into the mechanisms through which family firms can exert undue influence on internal control over financial reporting.