Ownership structure and accounting quality: A study on Swedish private equity backed companies

Abstract: This study investigates how private equity ('PE') ownership affects the accounting quality of its portfolio companies. By using a unique sample of private Swedish PE-backed companies and a non-PE-backed control group, our findings indicate that PE-backed firms exhibit lower accounting quality when measured as discretionary accruals. These results are overall robust to different estimates and model specifications. We interpret the findings as the incentives for general partners ('GPs') to engage in earnings management outweigh the potential negative consequences. However, examining accounting quality through conditional conservatism did not clearly indicate a difference between the groups. Further, we document that the PE-backed companies following a principle-based reporting framework (K3) exhibit significant higher absolute levels of discretionary accruals than the ones following a rule-based framework (K2) for two of the models. Given the substantial share of PE-backed companies that voluntarily adopt K3 after being acquired, our findings could potentially indicate that PE funds use reporting framework as a vehicle to enable more earnings management. Additionally, our study sheds light on how PE funds typically change group structures and consolidation levels, revealing the complexities of doing accounting research on PE-backed firms. More importantly, we present a novel and practical way how researchers can overcome these difficulties and perform accounting research on PE-backed firms in the future.