We investigate whether the financial accounting choices made by German private firms depend on legal form. Legal form determines dividend rights, liability status and the owners' obligations to run the business and, thus, influences agency problems of debt and equity. Consequently, we find that earnings properties depend on legal form. We expect, and find, that corporations exhibit higher levels of income smoothing and conservatism than partnerships and one-person businesses. Corporations are also more likely to disclose small profits. However, generally, there are no significant differences in earnings properties between one-person businesses and partnerships. The results are robust to different econometric specifications including endogeneity concerns (e.g. propensity score matching). Earnings properties of private firms seem to be driven to a considerable extent by agency problems of debt.

We analyze income smoothing in private small and medium-sized enterprises (SMEs) in Germany using a unique database of the German central bank containing around 18,000 firm-year observations. Due to reduced agency problems of debt, we expect and find that unlimited liability firms (sole proprietors, partnerships) have less need to disclose stable net income than limited liability firms (corporations). Income smoothing with unlimited liability firms is approximately 20% to 30% lower. Further, we expect and find that unlimited liability firms have stronger incentives to smooth income for tax reasons. Income smoothing significantly increases with bank debt, but only in corporations. To sum up, income smoothing of private firms is not homogeneous but is significantly affected by the legal status and its various motives including information provision, contracting and tax reduction.