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Review of Quantitative Finance and Accounting

Erschienen in:

02.04.2016 | Original Research

Corporate governance, ownership structure and managing earnings to meet critical thresholds among Chinese listed firms

verfasst von: Liona Lai, Henry Tam

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 3/2017

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Abstract

This study investigates the behaviors of Chinese listed firms in using non-operating below-the-line items to manage earnings to meet rights-issuance threshold and to avoid delisting, and whether ownership structure and certain corporate governance mechanisms are related to such earnings management behaviors. The present empirical analyses document that the likelihood of managing earnings to meet these critical regulatory thresholds is negatively related to the adoption of independent directors in the board of directors and to the percentage shareholdings of the largest shareholders and positively related to the percentage share of state ownership in China. Further investigation documents that the relationship between earnings management and the fraction of independent directors in the board could be non-linear. There is little evidence, however, that board size, percentage shareholdings of CEO, the duality of CEO and top director of the board, the quality of external auditor, or foreign ownership is related to such earnings management measure. Using the distribution approach to detect earnings management, this study supplements the extant literature on the relationship between corporate governance, ownership structure and earnings management using traditional accrual-based measures. This study offers insights to policy makers, particularly those in emerging economies, about the inducement of earnings management behaviors by government regulations and the prescription to deter earnings management behaviors by encouraging certain internal corporate governance mechanisms.

Vorheriger Artikel The bond event study methodology since 1974

Nächster Artikel The affine styled-facts price dynamics for the natural gas: evidence from daily returns and option prices

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While issuing corporate bonds is another typical channel for firms to raise funds in many different countries, Chinese firms are reluctant to raise capital through corporate bonds. This could be attributed to the Chinese culture of avoiding debt and the bitter experience of high debt burden during the pre-reform period.

Our statistical test supplements the often-used lack-of-smoothness test around critical thresholds to demonstrate existence of earnings management in the literature (Burgsthaler and Dichev 1997; Degeorge et al. 1999; Yu et al. 2006).

We include both state ownership variables as well as top shareholders’ shareholdings in the same regression to avoid misspecification due to correlated omitted variable bias problem. However, there might be a concern that since the state owns a majority of shares in quite a lot of listed firms in China, there might be potential multicollinearity problem by including state ownership variables and top shareholders’ shareholdings in the same regression. A check for multicollinearity among independent variables, however, indicates no reason for concern. Results are not reported here but could be obtained from the authors.

We also check for the robustness of our results by controlling for industry-fixed effects. Because the analysis involves a small subsample of 139 firm-year observations, it is only possible to use one-digit industry classification for our robustness test. Even then, some one-digit industries do not have enough representation in the subsample. We therefore use an industry dummy for each one-digit industry that has more than 5 observations in the subsample. The resultant 5 industry dummies include information technology, agriculture, manufacturing, wholesale and retail, and conglomerate. The results after controlling for industry-fixed effects are essentially similar to the ones reported in Tables 4 and 5.

The econometric theory of such sample selection problem when dependent variables are dichotomous and disturbances are non-normal is not well-developed yet. Thus, we assume disturbances are normally distributed and use the corresponding bivariate probit model.

To economize on space, we do not report such bivariate tests of the statistical relationship between the dichotomous selection variable and each individual corporate governance or ownership structure variable. Readers interested in the results could contact the authors.

In the standard sample selection bias model with continuous \(y_{1it}\), Heckman (1979) demonstrates that the sample selection problem could be interpreted as an omitted variable problem given by \(E(y_{1it} |y_{2it} = 1,X_{1it} ,X_{2it} ) = X_{1it} \beta_{1} + \rho \sigma_{u} \frac{{\Phi (X_{2it} \beta_{2} )}}{{\Phi (X_{2it} \beta_{2} )}}\) where \(\frac{{\Phi (X_{2it} \beta_{2} )}}{{\Phi (X_{2it} \beta_{2} )}}\) is the inverse Mills ratio which could be treated as an omitted variable with the estimated \(\beta_{2}\) using a simple probit regression on selection equation replacing the true value of \(\beta_{2}\) and \(\rho \sigma_{u}\) is the coefficient to be estimated in the primary equation of interest when \(\frac{{\Phi (X_{2it} \beta_{2} )}}{{\Phi (X_{2it} \beta_{2} )}}\) is included as an additional variable. Although a significant \(\rho\) is indicative of the existence of sample selection problem, there might not be sample selection bias on the coefficient of certain variable of the primary equation of interest. Bias exists only if \(\rho\) is significant and the omitted variable \(\frac{{\Phi (X_{2it} \beta_{2} )}}{{\Phi (X_{2it} \beta_{2} )}}\) is correlated to the variable of interest.

We also carry out a sensitivity analysis by increasing the bin size from the 1 % bin size we use below and above the critical thresholds under consideration. The issue is that, as bin size increases, our dependent variable is measured with more noise and thus statistical inferences are less reliable, though the sub-sample size will increase. Our results are essentially unchanged in Tables 4, 5, 6 and Table 7, if we use a 1.25 % bin size below and above the critical regulatory thresholds. However, as we increase the bin size further to 1.5 or 2 % below and above the critical thresholds, most of our signed impacts for board independence, ownership concentration and ownership types are still intact but some coefficients become statistical insignificant. These results in a way illustrate the importance of using a neat and powerful earnings management measure in earnings management studies.

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Titel: Corporate governance, ownership structure and managing earnings to meet critical thresholds among Chinese listed firms
verfasst von: Liona Lai
Henry Tam
Publikationsdatum: 02.04.2016
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 3/2017
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-016-0568-y

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