Corporate governance and income smoothing in China

Abstract

Purpose

The purpose of this paper is to examine empirically whether corporate governance mechanisms have an effect on income‐smoothing behavior in the People's Republic of China.

Design/methodology/approach

The sample comprises 1,358 companies listed in the Shanghai Stock Exchange and the Shenzhen Stock Market during the period 1999 to 2006. By comparing the variability of income to the variability of sales, an income smoother can be identified if income is less variable than sales.

Findings

The authors' empirical results show that income smoothing is more severe when the state is the controlling shareholder of the Chinese listed firm. Firms with more independent directors are more likely to engage in income smoothing. The governance mechanisms such as board of directors, supervisory board, audit committee, external auditors, and shareholders' participation are not effective in curtailing income smoothing in China.

Practical implications

For Chinese firms and especially government‐linked enterprises, the way in which they present themselves may be significant, since the image they present to potential strategic partners may be marred by suspicions of income smoothing.

Originality/value

The paper presents the current development of China's corporate governance system and indicates that agency conflicts between controlling shareholders and minority investors account for a significant portion of earnings management in China.

Citation

Yang, C., Leing Tan, B. and Ding, X. (2012), "Corporate governance and income smoothing in China", Journal of Financial Reporting and Accounting, Vol. 10 No. 2, pp. 120-139. https://doi.org/10.1108/19852511211273688