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Earnings management and listing regulations in China

Tao Li (Department of Government and Public Administration, University of Macau, Macau, China)
Mi Luo (Department of Economics, New York University, New York, New York, USA)
David Ng (Dyson School of Applied Economics and Management, Cornell University, Ithaca, New York, USA)

China Finance Review International

ISSN: 2044-1398

Article publication date: 13 May 2014

910

Abstract

Purpose

The purpose of this paper is to document earnings management of Chinese firms.

Design/methodology/approach

The paper takes advantage of the introduction of stringent delisting requirements around 2000 that non-cross-listed firms with consecutive earnings losses for more than two years would be delisted from the mainland Chinese exchanges. The paper examines whether listed firms in Chinese market manage earnings to avoid listings. The paper also examines whether mainland Chinese firms cross-listed in Hong Kong exchanges manage earnings the same way. The measure for earnings management is derived from a kernel density estimate for the return on equity distribution, following Bollen and Pool (2009).

Findings

The paper finds that the new delisting threats induce rampant earnings management on mainland markets, and cross-listing in Hong Kong has a curbing effect on earnings management. The paper also finds that prices became less value relevant after the implementation of delisting regulations, and investors rationally discounted the reliability of earnings announcements in China. Such market responses were absent for cross-listed firms in Hong Kong.

Originality/value

There is little conclusive evidence about whether cross-listing in a non-US market has a curbing effect on earnings management. The paper contributes to this literature by using this unique exogenous policy change in China and following a difference-in-difference approach in identifying the potential curbing effect. The particular measure adapted from Bollen and Pool (2009) utilizes information of the whole distribution of return on equity, thus extends earlier crude comparison of nearest two bars around zero and partially deals with the potential endogeneity problem.

Keywords

Acknowledgements

JEL Classifications — C14, G18, M41

The authors thank Murillo Campbello, George Gao, Andrew Karolyi, Pamela Moulton, Yang Yao, Hongqi Yuan, and other participants in a Cornell brown bag workshop, a China Center for Economic Research workshop at the Peking University, seminars at the University of Hong Kong, and the Chinese University of Hong Kong, Summer Institute of Finance Conference 2012 in Qingdao, for comments. Any errors are the authors own.

Citation

Li, T., Luo, M. and Ng, D. (2014), "Earnings management and listing regulations in China", China Finance Review International, Vol. 4 No. 2, pp. 124-152. https://doi.org/10.1108/CFRI-02-2014-0005

Publisher

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Emerald Group Publishing Limited

Copyright © 2014, Emerald Group Publishing Limited

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