The effect of ownership structure on the relationship between free cash flow and profit management in companies listed on the Tehran Stock Exchange.

Dissertation for Master's Degree

Field: Accounting

Abstract

One of the existing mechanisms in order to reduce the agency problem and reduce the information asymmetry between shareholders and managers in the capital markets is the corporate governance system. The role of institutional shareholders in corporate governance and their presence in companies has been the subject of many discussions in recent years. The main purpose of this research is to investigate the effect of ownership structure on the relationship between free cash flow and profit management in companies listed on the Tehran Stock Exchange. The size of the studied sample includes 115 companies in the period of 2016-2018. The combined data method was used to test the research hypotheses. The summary and general conclusion of the research hypotheses test shows that there is a significant relationship between the variables of free cash flow, ownership structure, on the relationship between free cash flow, and profit management in the studied period, and the main hypotheses of the research are proven. Key words: ownership structure, free cash flow, institutional ownership, managerial ownership, profit management, mixed data method.

Introduction

Cash funds of companies have always been the concern of stakeholders in companies, and the ability of cash funds of companies in the future and the ability to predict it can be a very useful help to their decisions in buying and selling shares and giving credit to companies, as well as a warning to managers to improve their performance. In the field of financial management, the use of scientific techniques, methods and models, generally to help make reasonable decisions in the financial affairs of companies and other organizations, has become extremely popular. And following that, many accounting and financial researches have focused on creating a model for predicting the financial and economic status of companies. In this regard, financial ratios are considered to be one of the most important tools in predicting the financial status and financial crises of companies. Growth is effective and efficient in financial evaluations, and it can be used to distinguish healthy companies from unhealthy companies (Fernandez, 2013) with the separation of ownership and management in joint-stock companies, a potential conflict of interest was created between shareholders and managers, which is called the "agency problem". One of the results of the agency problem is that there is an information asymmetry between the managers and the shareholders of the company and the shareholders cannot observe the actions and activities of the managers continuously, this information asymmetry causes two problems of adverse selection and moral hazard. On the other hand, accrual accounting gives significant choice to managers in determining profit in different time periods. In fact, under this type of accounting system, managers have significant control over the recognition time of some cost items, including advertising costs and research and development expenses. Also, in the accrual accounting system, managers are faced with different options regarding the recognition time of income, including faster recognition of income through credit sales. This type of performance by managers is called "profit management" in a simple phrase. The main purpose of this research is to investigate the effect of ownership structure on the relationship between free cash flow and profit management in companies listed on the Tehran Stock Exchange. In this chapter, we will present the generalities of the research.

1-2 Statement of the problem

Accounting profit is identified based on the accrual basis. Usually, the use of the accrual basis causes the amount of reported operating profit to be different from the net cash flows resulting from operations and the reporting of a series of accrual items in the financial statements. Dicho et al. (1995) showed. Non-discretionary accruals are fixed and cannot be used to smooth profit. Rather, the more discretionary accrual items are included in the accrual items, the more likely profit management will be.The opportunity for profit management is greater in companies with free cash flow, because managers of economic units with high free cash flow and low growth opportunities often tend to invest in additional projects or even in projects with negative net present value (Negative NPV) and to hide and cover the effects of investments that do not maximize shareholder wealth, they use optional accrual items that increase profits. On the other hand, the composition of shareholding or ownership structure [1] is considered as one of the important issues of corporate governance, which affects the motivation of managers and thus can have a significant effect on the efficiency of any company. In the past, economists assumed that all groups related to a joint-stock company work for a common goal, but during the last 3 decades, many cases of conflicts of interest between groups and how companies face such conflicts have been raised by economists. These cases are generally referred to as "representational theory". Therefore, with regard to the issues presented in order to solve the mentioned problem, in this research, the effect of ownership structure from the aspect of ownership type (institutional ownership, managerial ownership) as corporate governance mechanisms on the adjustment of the relationship between free cash flow and profit management is examined. Therefore, the basic research question that engages the researcher's mind is: Can the diversity of owners moderate the negative relationship between free cash flow and profit management. or not        Millions of people who have entrusted their savings by investing in corporate securities rely on the annual and interim financial statements of companies to ensure that their invested funds are being used correctly and effectively. Even more people leave their savings to banks and other institutions, which in turn invest these funds in corporate stocks. Therefore, almost every person directly or indirectly has interests in companies, and maintaining public interests requires reliable and timely financial reports of the operations and financial health of public companies. There are two views regarding the desired goal of the company: Some say: the desired goal of the company is profitability. But can't profitability be the desired goal of the company?

     The biggest drawback of the goal of profitability is that profit is vague and because it is influenced by accounting procedures, it can be manipulated (Qalibaf Asl, 1387, p. 1-2).

1. When companies in an unfavorable economic situation are under increasing future pressure, their managers request accounting to improve the bottom line of financial statements (i.e. profit), thereby changing their information content. Accounting, despite all its flexibility, does not seem to be able to provide useful data for management in such conditions. The data required for decision-making is a very complex category, because the diverse range of its users, such as investors (since they need to know the profitability and stability of the company before investing in it), managers (need to know the financial status of the company), banks and financiers (need to know the ability of the company to repay the loan) need various information (Norush et al., 2014, p. 166).

2. One of the methods that is sometimes used to inform the favorable situation of companies is profit management. Profit management refers to the general intervention of management in the process of determining profit, which is often in line with the desired goals of management. Profit management is a method used by management to manipulate data. For example, smoothing the profit to make investors more confident about the stability of the profit is an example of data manipulation. Such actions may significantly affect the data in the financial statements.  

       Playing with "financial numbers" can have a very negative impact when discovered. By using profit management accounting, management can change the perceptions of others regarding its company's performance. The evaluation of the profitability of the company may be misinterpreted and cause the inappropriate determination of the price of debt and equity securities. When mistakes are discovered. The company will no longer gain market confidence. Researches have shown that the low and stable fluctuation of profit indicates its quality. In this way, investors invest with more confidence in the shares of companies whose profit trends are more stable.