Do common auditors mitigate classification shifting in the family business groups? Evidence from emerging economy

Abstract

Purpose This study examines the role of common auditors in curbing classification shifting in family business group (FBG) affiliated firms, particularly in the context of family-dominant firms having poor corporate governance and investors’ protection. Design/methodology/approach We tested the study's hypothesis using manually collected data from 286 firms of Pakistan Stock Exchange (PSX) listed firms for the period of 2010–2019. This research paper employs advanced panel data regression models to examine the role of common auditors in mitigating classification shifting as proxied by McVay's (2006) core earnings model in the FBG-affiliated firms. Findings This study finds that stand-alone firms are involved in classification shifting. However, FBG-affiliated firms are not involved in classification shifting to increase core earnings. Moreover, the common auditors, including BIG-4 common auditors, are effective in mitigating classification shifting in the FBG-affiliated firms. Robust regression analysis and alternative measures support the study's findings. Research limitations/implications This research study has important implications for companies’ managers and owners, policymakers, investors and regulators by reinforcing the vital role of common auditors and BIG-4 common auditors in preventing classification shifting in the FBG-affiliated firms. The evidence of classification shifting in the PSX firms raises questions on the financial reporting quality, which may be used cautiously by investors and regulators when evaluating their financial reporting quality. Hence, the regulator(s) may consider the practice of classification shifting in the stand-alone firms to protect shareholders’ interests and the role of common and BIG-4 common auditors in the FBG-affiliated firms. In addition, the regulators, policymakers, auditors and potential investors may focus on the line-item segregation in the income statements of their interested companies. Originality/value This research study, to the best of the author's knowledge, is the first to investigate the role of common auditors in FBG-affiliated firms to curb classification shifting. Moreover, through this research study, new evidence has been provided that common and BIG-4 auditors have played a significant role in curbing EM via classification shifting in emerging economies having features of institutional voids and weak corporate governance.