John Christian Langli

Accounting diversity and firm valuation

This study examines the relation between accounting numbers and stock prices across three countries: Germany, Norway, and the United Kingdom (UK). The analysis follows the residual income valuation model. Accounting in the three countries varies in faithfulness to clean surplus accounting and in bias (conservatism). We address three questions. Are there differences across countries in the value relevance of accounting? Second, are there differences in the incremental and relative value relevance of book values and earnings per share (EPS)? Third, do future earnings realizations explain current stock prices? We find book value and EPS are positively and significantly related to stock prices across all three countries. German accounting numbers have the lowest relation with stock prices (R2 40%), while UK and Norwegian accounting numbers explain 70% and 60% respectively of variation in stock prices. Second, the incremental and relative value relevance of book value and of EPS differs across time and countries. Book values explain more than EPS in Germany and Norway, but less in the UK. Finally, future income realizations explain little about market prices not explained by current book value and EPS.

Taxable income differences between foreign and domestic controlled corporations in Norway

Studies mainly in the United States and United Kingdom have documented that foreign controlled corporations (FCCs) report significantly lower taxable income compared to domestic controlled corporations (DCCs). This taxable income differential has been partly attributed to income shifting by multinational corporations. Using a sample of 78,879 firm-year observations from 1993 to 1996, we find similar systematic differences for firms in the manufacturing, retail and wholesale sectors in Norway. The taxable income to sales ratio is approximately 2.6 percentage points lower for FCCs compared to DCCs after controlling for start-up costs, size, industry affiliation, leverage and capital intensity. The results are statistically significant in all years and independent of whether taxable income is measured as a fraction of sales, total assets or book value of equity. Previous research has indicated that income shifting is more prevalent among large firms. This study provides evidence on small and medium-sized firms operating in Norway. With the exception of really small corporations in the manufacturing industry (e.g. with sales less than 6.7 million NOK or US

Earnings Management Priorities of Private Family Firms

1 million), we find that the negative taxable income differential exists independent of the size of the corporations.

Governance Structure and Firm Performance in Private Family Firms

We use a unique database on family relationships between CEOs, board members and owners of private Norwegian firms to examine earnings management priorities of private family firms. Consistent with agency theory we find that private family firms generally manage earnings downward compared with non-family firms. However, tendencies to inflate earnings increase with leverage, and among highly leveraged private firms we find that those that are family controlled manage earnings upward more extensively than others. This result suggests that preservation of control may be more important for family shareholders than for other owners. Having a CEO who is a member of the controlling family amplifies both the general tendency of shrinking earnings and the conditional tendency of inflating them. Conversely, having an independent board member moderates both tendencies. The distinct earnings management tendencies of private family firms tend to weaken as the firm grows older. This result is consistent with the generational effects on family firm characteristics that have been reported in prior family business research.

Determinants of Executive Compensation in Private Family Firms

Although a large proportion of firms are family owned and most family firms are private, our understanding of private family firms is limited. Using confidential information on family relationship between board members, CEOs, and shareholders, this is the first study that provides large-scale evidence on the association between governance structure and firm performance in family controlled private firms. Our sample is unique as it covers almost all private limited liability firms in Norway, spans 11 years, traces firm ownership to ultimate owners, and identifies family relationship using data on kinship, marriage, and adoption. The results show a U-shaped relationship between family ownership and firm performance. Higher ownership of the second largest owner, higher percentage of family members on the board, stronger family power, and smaller boards are associated with higher firm performance. In addition, the positive association between the ownership of the second largest owner and firm performance also occurs when the second largest owner is a member of the controlling family, but the association is stronger when the second largest owner is a non-family member. We further test the relative importance of these test variables and find that ownership structure is more associated with firm performance than board structure.

Audit Exemptions and Compliance with Tax and Accounting Regulations

We study patterns of CEO compensation in private family firms. We find that private family firms pay their CEO less than other private firms, and that the tendency of low CEO pay is stronger in family firms that have a family member as CEO. More than in other firms CEO pay in private family firms is positively associated with performance, which is contrary to some findings regarding public firms. Private family firms more than other private firms shield the CEO from business risk, in particular when the CEO is a member of the controlling family. We find that private family firms compensate their CEO for systematic risk, whereas non-family firms rather compensate for unsystematic risk.

Does the Big-4 Effect Exist in the Private-Client Segment? Evidence from Audit-Partner – Auditee Pair Switches

We examine small firms’ compliance with tax and accounting regulations before and after a change in the threshold for mandatory auditing. Prior to 2011, all Norwegian firms were required to be audited. In 2011, a law change allowed small Norwegian firms to choose not to be audited. After this change, the Norwegian Directorate of Taxes conducted on- and off-site inspections of a representative sample of 2117 Norwegian firms, with a focus on compliance with specific requirements in tax and accounting regulation. We use the results from these inspections to construct a compliance quality score (CQS). We find that the firms that chose to opt out of auditing have lower CQS than do firms that chose to continue to be audited; that the CQS of firms that chose not to be audited declined after opting out; and that some of the opt-out firms fully mitigated the decline in CQS by engaging external accountants or auditors to prepare their annual financial statements. The results should be of interest to regulators considering increasing the thresholds for mandatory auditing, as our results show that (i) firms that choose not to be audited can experience a decline in CQS after opting out and (ii) CQS can be maintained at the same level as before if opt-out firms engage external consultants that assist in preparing the annual accounts.

Auditor Independence in a Private Firm and Low Litigation Risk Setting

This paper studies whether Big-4 firms provide higher quality audits relative to non-Big-4 firms when the characteristics of audit partners and auditees are held constant. When an audit partner switches her affiliation with an audit firm to a different firm, some auditees follow the partner (hereafter, the partner-auditee pair). Employing a unique dataset of individual auditors for a large sample of private companies in a setting with documented low litigation and reputation risk, we analyze audit quality of the partner-auditee pairs that switch affiliations between Big-4 and non-Big-4 firms. We proxy for audit quality using measures of earnings management, deviations from clean audit reports, and accuracy of going-concern reporting. Our evidence is consistent with a Big-4 effect. We find less earnings management, higher going-concern accuracy, and higher audit fees after a switch from a non-Big-4 firm to a Big-4 firm. For switches from Big-4 firms to non-Big-4 firms, we find lower going-concern reporting accuracy and lower audit fees after the switch. We further show that the increase in going-concern accuracy and the decrease in earnings management coincide with a lower likelihood of issuing modified audit reports; we attribute this effect to the Big-4 firms’ ability to more accurately identify and evaluate financially-troubled auditees and their greater competency and independence to provide higher quality financial reporting by the auditees, resulting in less use of modified reports.