Earnings management during family firm succession: an analytical perspective of the influence of socioemotional wealth

In order to provide an analytical explanation for earnings management in family firms prior to a succession, we study a two-period agency setting in which a founder can invest in the future capital stock and may engage in earnings management. We examine two succession scenarios which differ in terms of who lead the firm in the second period. To capture dynastic and altruistic motives of the founder, we incorporate the behavioral concept of socioemotional wealth (SEW). Our model shows that SEW creates manipulation incentives. We find that the founder engages in both accrual-based and real earnings management in order to reduce inheritance tax payments for the offspring.  We  show how the successor’s productivity, inheritance taxation, and internal monitoring influence the founder’s choice between a family-member and an external manager as the future CEO.