Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
Earnings Management by Top Chinese Listed Firms in
Response to the Global Financial Crisis
Guanglu Xu* and Xu-Dong Ji**
This paper examines Chinese firms’ earnings management behaviors, including both
accrual and cash flow based earnings management, before and during the Global
Financial Crisis (GFC) from 2004 to 2009. The results show that the top Chinese listed
firms, especially those covered by the government stimulus package, engaged in
income-increasing cash flow based earnings management. The results reflect the positive
impact of the 4 trillion RMB stimulus package launched by the Chinese government. In
addition, our findings show that managers increasingly prefer real earnings manipulations
to accrual based earnings management.
JEF Codes: M21, M41 and M48
1. Introduction
At the start of the Global Financial Crisis (GFC) in 2008 China’s economy
experienced a significant downturn, which could be illustrated by the considerable
decreases in China’s GDP, export, and the stock market value. As a response to
these influences of the GFC, the Chinese government launched a series of measures
within which the most remarkable measure is the so-called 4 trillion RMB stimulus
package. Thanks to these swift and effective governmental interventions China’s
economy came back to its normal level in a quite short period (Yu, 2009). The primary
objective of this paper is to examine the earnings management of the top Chinese
listed firms in response to the GFC through both accrual based earnings
management and real activities manipulations, while taking into consideration the
influence of Chinese government’s interventions.
Our results show that the top Chinese listed firms, especially those covered by the
stimulus package, engaged in income-increasing cash flow based earnings
management by manipulating production costs downwards in response to the GFC.
On the other hand, no significant results are found that the top Chinese listed firms
using discretionary accruals to manipulate earnings during GFC period. The results
are robust after controlling the influence of firm characteristics, such as size, leverage,
audit quality, performance, and growth, etc.
Our study contributes to the literature in the following aspects. Firstly, it investigates
the top listed Chinese firms’ earnings management behaviors in response to the GFC.
Secondly, it assesses the effectiveness of the stimulus package launched by the
Chinese government, and it demonstrates that firms covered by the stimulus package
managed earnings upwards to boost or to smooth performance rather than taking a
bath. Thirdly, this study provides the evidence supporting the argument that
managers increasingly prefer real earnings manipulations to accrual based earnings
management nowadays (Roychowdhury, 2006; Li, McDowell and Moore, 2008;
Cohen et al, 2008).
*Guanglu Xu, Department of Accounting, La Trobe University, Australia.
Email: g5xu@students.latrobe.edu.au
**Dr. XuDong Ji, Department of Accounting, La Trobe University, Australia. Email :x.ji@latrobe.edu.au
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
This paper is structured as follows. Section 2 presents the literature review of
earnings management. Section 3 discusses the hypothesis development and
research methodology. The empirical results are interpreted in Section 4. Finally,
Section 5 contains the conclusion and possible future research opportunities.
2. Literature review
Managers have different incentives to engage in earnings management (Healy and
Wahlen,1998). Managers would manipulate the reported earnings to increase their
awards and personal wealth when their compensation and bonus are tied to firm
performance (Watts, 1977; Watts and Zimmerman, 1978; Healy, 1985); to avoid the
violations of the restrictive covenant in the lending or debt contracts, otherwise, such
violations would impose heavy costs on firms (Defond and Jiambalvo, 1994; Ahmed
and Saleh, 2005); to influence their stock prices or the book value of their assets prior
to acquisitions, buyouts or IPOs (Teoh et al, 1998; Scott, 2009); or to minimize the
political cost as a result of the violations of governmental or industrial regulations
(Wong, 1988). During a management turnover, new managers are also likely to
deliberately manage earnings downwards in order to blame their predecessors for
poor performance, which also allows them to report higher growth during their term of
office (Godfrey et al, 2003).
Scott (2009) classifies earnings management into four major patterns: taking a bath,
(Healy, 1985; DeAngelo, 1988), income minimization (Shuto, 2007), income
maximization (Guidry et al, 1998), and earnings smoothing (McNichols and Wilson,
1988). Two major earnings management methods are employed by firms to realize
the four patterns of earnings management: accrual-based and cash flow-based
earnings management. Cohen and Zarowin (2010) argue that the major distinction
between accrual based and cash flow based earnings management activities is that
cash flow based earnings management involves the manipulations of real business
activities, such as the increases in sales or reductions in inventories that involve cash
transactions. Therefore, real earnings management has the direct impact on cash
flows. Roychowdhury (2006) reports that managers engage in real earnings
management activities in order to avoid reporting annual income losses or to increase
reported earnings. These activities include (1) offering price discounts or more lenient
credit terms to temporarily increase sales, (2) aggrandizing production in order to
lessen cost of goods sold, and (3) reducing discretionary expenditures, including
research and development costs, sales and distribution expenses, advertising
expenses, etc.
The literature has provided limited empirical evidence regarding firms’ reactions to
financial crisis by means of earnings management. Ahmed and Saleh (2005) examine
the earnings management of financially distressed firm in debt renegotiation during
the Asian Financial Crisis. They find that financially distressed firms manipulate
earnings downward during the 1997 Asian Financial Crisis in Malaysia. Kim and Yi
(2006) explore the earnings management behavior of firms in Korea during the 1997
Asian Financial Crisis. Their results indicate that public firms engage in earnings
management to a larger extent than private firms. Chia et al (2007) find that
service-oriented firms in Singapore engaged in income-decreasing earnings
management or taking a bath during the period of the 1997 Asian Financial Crisis.
Charoenwong and Jiraporn (2009) also examine the reactions of firms in Singapore
and Thailand to the 1997 Asian financial crisis. Their results reveal that firms that
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
were less affected by financial crisis in these two countries use earnings
management to avoid reporting losses and negative income growth. However, these
studies investigate only one type of earnings management, either accrual based
earnings management or real activities manipulations.
3. Methodology
Financial crisis or economic recession would provide corporate managers with
various incentives to manipulate earnings. It shows that financial crisis tends to force
firms to be financially distressed. For example, Ahmed and Saleh (2005) report that
during the 1997 Asian Financial Crisis most Malaysian corporations suffered a
significant falloff in both output and profitability. Besides the financially distressed
firms, it is also possible that firms that are less affected by the financial crisis could
engage in income-increasing earnings management in order to avoid reporting losses
and negative earnings growth (Charoenwong and Jiraporn, 2009).
This argument is relevant to the situation in China during the GFC because the top
Chinese listed firms were less affected by the GFC and had incentives to engage in
income-increasing earnings management. Firstly, for export-oriented firms that
experienced significant decrease in export as a result of the decrease in the
consumption levels of major developed economies, China’s domestic market is still
huge, which allows them to transfer their sale from overseas market to domestic
market. More importantly, the Chinese government always strives to keep the
development of the national economy at a stable pace. In order to protect China’s
economy and Chinese firms from the influence of the GFC, a series of measures
were initiated, and the most remarkable measure was the 4 trillion RMB stimulus
package. Because of these effective governmental interventions, the economic
recession in China did not last for more than a quarter. The sales and financial
performance of Chinese firms, especially the firms covered by the stimulus package,
were not affected severely. One of the reason we suspect is that top Chinese listed
firms, especially those covered by the stimulus package, would engage in
income-increasing earnings management to further boost their financial performance
during the GFC. Based on the above discussions, our hypotheses are established as
follows.
H1: Top Chinese listed firms did engage in accrual based earnings management
during the Global Financial Crisis (GFC).
H1a: Top Chinese listed firms, covered by the stimulus package, engaged in
income-increasing accrual based earnings management during the Global Financial
Crisis (GFC).
H2: Top Chinese listed firms did engage in cash flow based earnings management
during the Global Financial Crisis (GFC).
H2a: Top Chinese listed firms, covered by the stimulus package, engaged in
income-increasing cash flow based earnings management during the Global
Financial Crisis (GFC).
In this study discretionary accruals are estimated by using Kothari (2005) model. In
order to estimate discretionary accruals, total accruals are calculated by using the
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
balance sheet approach. This approach is prevalently used in the literature (Healy,
1985). In our study, the cross-sectional Kothari (2005) model is used because this
model is argued to be more powerful in estimating discretionary accruals (Bartov et al,
2001; Ahmed and Saleh, 2005):
TAit
Salesit
PPEit
1
 k1  k2
 k3
 k4
 k5 ROAit   it
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
(1)
where, for fiscal year t and firm i:
TAit  NCCAit  CLit  DEPit  AMOit
(2)
TAit = total accruals, which is defined using the balance sheet approach as above;
Assetsi ,t 1 = beginning total assets;
Salesit = the sales changes net of the change in accounts receivables;
PPEit = the net amount of property, plant and equipment;
ROAit = the return on assets ratio, it is calculated as net income divided by total assets;
NCCAit = the change in non-cash current assets;
CLit = the change in current liabilities;
DEPit = depreciation expenses;
AMOit = amortization expenses.
For each financial year, equation (1) is estimated for each of the ten industry groups
classified by the four-digit GICS code. This approach could control for the differences
among industry groups that may have impacts on total accruals and allow the
coefficients to change over the sample period as suggested by Defond and Jiambalvo
(1994) and Cohen and Zarowin (2010). The coefficients estimated from equation (1)
are used to estimate the non-discretionary accruals (NA):


NAit  k1  k 2



Salesit
PPEit
1
 k3
 k4
 k 5 ROAit
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
(3)
Therefore, discretionary accruals (DA) are estimated as the prediction errors (εit ) in
equation 1, which are the difference between total accruals (TA) and the estimated
non-discretionary accruals (NA).
The cross-sectional Roychowdhury (2006) model is applied to detect cash flow based
earnings management. Three metrics are considered: the abnormal levels of CFO,
production costs and discretionary expenditures. Roychowdhury (2006) explains the
three methods of real earnings manipulations as follows:
1. Sales manipulations: this involves to offer price discounts or more lenient credit
terms by managers with the purpose of increasing current fiscal year’s sales.
Sales manipulations would lead to abnormally low CFO and high production costs.
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
2. Reduction of discretionary expenses: this involves to postpone discretionary
expenditures to future periods which leads to abnormally low discretionary
expenses and high CFO.
3. Overproduction: this involves to produce surplus goods in order to manipulate
earnings upwards. This behavior leads to abnormally high production costs and
low CFO.
However, in our study we argue that the situation in China in regard to production
costs is different to Roychowdhury’s explanation. Roychowdhury (2006) suggests
that when firms engage in overproduction to increase current period’s reported
earnings, there will be positive abnormal production costs because of the additional
production and holding costs on the overly produced inventory. In the Chinese
context, as we have explained earlier, the Chinese government initiated mass
infrastructure constructions and encouraged firms to increase outputs in order to
stimulate China’s economic growth during the GFC. The products of the top Chinese
firms were not overly-produced and appeared to be subsequently sold right after
production, thus there wouldn’t be excessive inventory or additional holding costs. For
example, the products of the construction material manufacturing firms would be
directly sold and used in the construction projects, such as the construction of
railways, highways and airports. Therefore, we expect that top Chinese firms
engaging in income-increasing real earnings manipulations would have positive
abnormal CFO and negative abnormal production costs.
Following previous studies, normal CFO is expressed as a linear function of sales and
change in sales and the equations below are run for each year and each of the ten
industry groups classified by 4-digit GICS code:
CFOit
Salesit
Salesit
1
 k1  k2
 k3
 k4
  it
(4)
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
where CFOit is the cash flows from operating activities. Salesit is the change in
sales defined as Salesit  Salesit  Salesi ,t 1 .
Cost of goods sold (COGS) is modeled as a linear function of contemporaneous
sales:
COGSit
Salesit
1
 k1  k2
 k3
  it
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
(5)
Change in inventory is presented as the linear function of contemporaneous and
lagged sales growth:
Salesi ,t 1
INVit
Salesit
1
 k1  k2
 k3
 k4
  it
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
(6)
where INVit is the change in inventory.
As the production costs are defined as the sum of COGS and change in inventory, the
normal level of production costs is estimated using regression (7),
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
Salesi ,t 1
PRODit
Salesit
Salesit
1
 k1  k2
 k3
 k4
 k5
  it
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
(7)
where PRODit is the production costs.
According to Roychowdhury (2006) and Cohen and Zarowin (2010), the normal level
of discretionary expenses is estimated by using the lagged sales rather than current
sales:
Salesi ,t 1
DISEXPit
1
 k1  k2
 k3
  it
Assetsi ,t 1
Assetsi ,t 1
Assetsi ,t 1
(8)
where DISEXPit is the discretionary expenses.
All the abnormal levels of CFO, production costs and discretionary expenditures are
estimated as the prediction errors (εit ) in equations (4) to (8). Again, all variables in
these equations are scaled by opening total assets and a constant is included in order
to reduce heteroskedasticity.
We estimate the following regressions to investigate the earnings management of top
Chinese listed firms as a reaction to the GFC.
𝐴𝐸𝑀𝑖𝑡 = 𝛼 + 𝛽1𝑃𝑂𝑆𝑇𝑖𝑡 + 𝛽2 𝑆𝑇𝐼𝑀𝑈𝐿𝑈𝑆𝑖𝑡 + 𝛽3 𝐶𝐹𝑂𝑅𝑖𝑡 + 𝛽4 𝐴𝑈𝐷𝐼𝑇𝑖𝑡 + 𝛽5 𝐿𝐸𝑉𝑖𝑡
+𝛽6 𝑀𝐵𝑖𝑡 + 𝛽7 𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽8 𝑌𝐸𝐴𝑅𝑖𝑡 + 𝛽9 𝐼𝑁𝐷𝑈𝑆𝑇𝑅𝑌𝑖𝑡 + 𝜀𝑖𝑡
𝑅𝐴𝑀𝑖𝑡 = 𝛼 + 𝛽1 𝑃𝑂𝑆𝑇𝑖𝑡 + 𝛽2 𝑆𝑇𝐼𝑀𝑈𝐿𝑈𝑆𝑖𝑡 + 𝛽3 𝑅𝑂𝐴𝑖𝑡 + 𝛽4 𝐴𝑈𝐷𝐼𝑇𝑖𝑡 + 𝛽5 𝐿𝐸𝑉𝑖𝑡
+𝛽6 𝑀𝐵𝑖𝑡 + 𝛽7 𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽8 𝑌𝐸𝐴𝑅𝑖𝑡 + 𝛽9 𝐼𝑁𝐷𝑈𝑆𝑇𝑅𝑌𝑖𝑡 + 𝜀𝑖𝑡
(9)
(10)
AEM is the dependent variable in regression (9), which refers to the discretionary
accruals (DA) estimated by using Kothari (2005) model. The dependent variable RAM
in regression (10) is the abnormal levels of real activities manipulations, including the
abnormal CFO, the change in inventory, COGS, production costs and discretionary
expenditures. We include two dummy variables, POST and STIMULUS, to examine
the influences of the GFC and the stimulus package on firms’ earnings management
in models 9 and 10. POST indicates if a firm-year observation is in the post-GFC
period, and STIMULUS shows if a sample firm is covered by the 4 trillion RMB
stimulus package.
4. Findings
The sample in this study includes 1,392 firm-year observations for 232 firms from
2004 to 2009. This sample period allows the comparison of the sample firms’
earnings management behaviors before and after 2008 when the GFC started, which
helps to investigate whether top Chinese listed firms engaged in earnings
management as a response to the economic crisis. The data is collected from the
OSIRIS and ThomsonONE databases, and it has been winsorized at both 1 st and 99th
percentiles in order to relieve the impact of outliers on the results. The sample
selection procedure is illustrated in Table 1.
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
Table 1: Summary of Sample Selection
Firm-year observations are selected from OSIRIS database
Chinese firms in OSIRIS database
Firms selected from 10 industries by 4-digit
GICS codes
Top 200 firms selected by total assets from 2007
to 2009
Sample period from 2004 to 2009
Final sample
2,383
2,383
1,822
1,822
232
232
1,392
1,392
1,392
Table 2 reports the descriptive statistics for the major measures of earnings
management and the control variables used in this paper. In Panel A, the mean of
absolute value of total accruals 0.134 and median is 0.089. The mean of absolute
value of discretionary accruals (DA) is 0.081 and mean is 0.061. In Panel B, the
means of the absolute values of cash flow-based earnings management measures,
CFO, ∆INV, GOGS, PROD and DISEXP, are 0.047, 0.033, 0.058, 0.053 and 0.134
respectively. For the control variables in Panel C, AUDIT refers to the total
remuneration of auditors over opening balance of total assets, on average, the audit
fees account for about 0.1% of the total assets. The average leverage ratio (LEV) is
60.3%, which indicates that top Chinese listed firms are highly leveraged. The
average market-to-book ratio (MB) is 45.1%. The average return on assets ratio
(ROA) of 5.5% shows that top Chinese listed firms have comparatively low financial
performance.
Table 3 compares the means of the unsigned or absolute values of earnings
management indicators before and during the GFC period. The results show that the
average absolute values of discretionary accruals (DA) increased significantly from
0.024 to 0.055 after 2008; the means of the abnormal levels of CFO, COGS, the
change in inventory, production costs and discretionary expenses have all changed
significantly.
Table 4 reports the results of the regression model (9). The results show that the
independent variables, POST and STIMULUS, do not have significant influence on
the dependent variable discretionary accruals (DA). Therefore, H1 cannot be
supported, which indicates that top Chinese listed firms, as well as the firms covered
by the stimulus package, did not engage in accrual based earnings management
during the GFC.
Table 5 presents the results about the sample firms’ cash flow based earnings
management during the GFC. Firstly, in the regression with abnormal production
costs (PROD) as the dependent variable, the coefficient of POST is -0.0282 that is
significant at the level of 5%. This shows that top Chinese listed firms as whole
engaged in income-increasing earnings management through the downward
manipulation of production costs. Secondly, the coefficient of STIMULUS is
significantly positive (0.0199) in the regression of abnormal CFO (CFO) and is
significantly negative in the regression of PROD. This confirms our expectation that,
in the Chinese context, firms engage in mass production to manage reported
earnings upwards. Based on these results, H2 and H2a hold true. Top Chinese listed
firms, especially the ones supported by the stimulus package, engaged in
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
income-increasing earnings management through the downward manipulation of
production costs in the post-GFC period.
Table 2: Descriptive Statistics for Major Earnings Management Indicators and
Control Variables
Variables
Mean
Median
Maximum
Minimum
Std. Dev.
Panel A: Accrual-based earnings management indicators
TA
0.134
0.089
3.767
0.000
0.229
DA
0.081
0.061
0.719
0.000
0.083
NA
0.118
0.089
3.682
0.001
0.207
Panel B: Cash flow-based earnings management indicators
CFO
0.047
0.029
0.709
0.000
0.063
∆INV
0.033
0.005
1.613
0.000
0.079
COGS
0.058
0.036
0.747
0.000
0.077
PROD
0.053
0.016
1.557
0.000
0.097
DISEXP
0.134
0.047
5.677
0.000
0.313
Panel C: Control variables employed in the regression models
AUDIT
0.001
0.000
0.031
0.000
0.002
CFOR
0.103
0.088
1.805
-0.298
0.137
LEV
0.603
0.620
0.965
0.171
0.175
MB
0.451
0.000
1.000
0.000
0.498
ROA
0.055
0.049
0.483
-0.394
0.065
SIZE
14.221
14.097
17.636
12.173
0.888
TA refers to the absolute value of total accruals, which is calculated following the balance sheet approach as the
change in non-cash current assets minus the change in current liabilities less total depreciation and amortization
expenses, scaled by lagged total assets; DA and NA refer the absolute value of the discretionary and
non-discretionary accruals generated following Kothari (2005) model for each industry group in each observation
year, and non-discretionary accruals are defined as total accruals minus discretionary accruals;
CFO, ∆INV, COGS ,DISEXP and PROD are the absolute values of abnormal levels of CFO, change in inventory,
COGS, discretionary expenses and production costs, which are generated following Roychowdhury (2006) model;
AUDIT refers to the total auditor remuneration deflated by the opening total assets; CFOR is the cash flow from
operations divided by beginning total assets; LEV is leverage calculated by dividing current total liabilities by current
total assets; MB refers to the market-to-book ratio; ROA is the return on assets ratio calculated as the net income
divided by current total assets; SIZE is the natural log of current total assets.
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
Table 3: Comparison of the means of unsigned discretionary accruals and the
abnormal levels of real activities manipulations during the GFC
Earnings
management
indicators
Mean
Standard Deviation
P value
Pre-crisis Post-crisis Pre-crisis Post-crisis
DA
0.024
0.055
0.057
0.080
0.000***
CFO
0.041
0.060
0.064
0.058
0.000***
COGS
0.053
0.069
0.078
0.075
0.000***
∆INV
0.022
0.055
0.056
0.107
0.000***
PROD
0.040
0.081
0.083
0.115
0.000***
DISEXP
0.157
0.088
0.369
0.141
0.000***
*, ** and *** indicate levels of significance at p<0.1, p<0.05 and p<0.01, respectively.
DA refers to the absolute value of the total residual generated following Kothari (2005) model, which is
the indicator of accrual-based earnings management. CFO, COGS, ∆INV, PROD and DISEXP are the
absolute values of the five indicators of cash flow-based earnings management, which are the
abnormal levels of CFO, COGS, and change in inventory, production costs and discretionary
expenses.
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
Table 4: Regression results about accrual based earnings management of top
Chinese listed firms as a reaction to the GFC
DA
Variables
Coefficient
P value
C
0.011
0.878
POST
0.005
0.605
STIMULUS
0.005
0.615
CFOR
-0.112
0.000***
AUDIT
0.342
0.835
LEV
-0.018
0.426
MB
0.006
0.426
SIZE
0.000
0.977
Year Dummy
yes
Industry dummy
yes
R-squared
0.058
Adjusted R-squared
0.016
*, ** and *** indicate levels of significance at p<0.1, p<0.05 and p<0.01, respectively.
DA is discretionary accruals estimated following Kothari (2005) model;
POST takes the value of 1 if a firm-year observation is in the post-crisis period;
STIMULUS indicates if a sample firm is covered by the stimulus package;
AUDIT refers to the total auditor remuneration deflated by the opening total assets; CFOR
is the cash flow from operations divided by beginning total assets; LEV is leverage
calculated by dividing current total liabilities by current total assets; MB is a dummy variable
that takes the value of 1 if current market-to-book ratio is below 1, and 0 otherwise; SIZE is
the natural log of current total assets.
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
Table 5: Regression results about cash flow based earnings management by top Chinese listed firms during the GFC
∆INV
CFO
COGS
PROD
DISEXP
Coefficient
P value
Coefficient
P value
Coefficient
P value
Coefficient
P value
Coefficient
P value
C
-0.006
0.933
-0.232
0.000***
0.243
0.001***
-0.148
0.085*
0.433
0.116
POST
0.005
0.636
-0.025
0.011**
-0.013
0.207
-0.028
0.028**
0.065
0.112
STIMULUS
0.020
0.061*
-0.037
0.000***
-0.034
0.002***
-0.051
0.000***
-0.066
0.125
AUDIT
-0.664
0.682
3.528
0.022**
-2.703
0.106
1.876
0.360
-17.007
0.010***
LEV
-0.052
0.025**
0.049
0.026**
0.052
0.031**
0.103
0.001***
-0.018
0.845
MB
0.010
0.195
0.008
0.270
-0.002
0.816
-0.002
0.824
-0.035
0.262
ROA
0.505
0.000***
0.062
0.275
-0.855
0.000***
-0.472
0.000***
0.116
0.634
SIZE
0.000
0.933
0.014
0.003***
-0.014
0.006***
0.009
0.141
-0.028
0.150
Year
Dummy
Industry
dummy
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
R-squared
0.1892
0.1325
0.3411
0.1750
0.2482
Adjusted
R-squared
0.1542
0.0951
0.3127
0.1394
0.2158
*, ** and *** indicate levels of significance at p<0.1, p<0.05 and p<0.01, respectively. RFO, GOGS, ∆INV, PROD and
DISEXP are the absolute values of the abnormal levels of CFO, COGS, the change in inventory, production costs and
discretionary expenses;
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
4. Conclusion
Although earnings management continues to be an important issue in the financial
accounting, the literature so far has provided limited evidence on firms’ earnings
management behaviours as a reaction to the Global Financial Crisis (GFC),
especially in developing countries, such as China. Our results show that top Chinese
listed firms did manage reported earnings upwards in order to boost performance or
to achieve income smoothing through the manipulation of production costs rather
than discretionary accruals. The results reflect the positive impact of the 4 trillion RMB
stimulus package launched by the Chinese government. We argue that the purpose
of such governmental intervention is to keep China’s economic growth stable even
under the situation of the GFC and to enhance China’s international image, as well as
people’s confidence in China’s economy. In addition, our findings also provide the
empirical evidence supporting the argument that managers increasingly prefer real
earnings manipulations to accrual based earnings management.
There may still be some limitations. Firstly, our sample firms are selected from the
exported-oriented industries only. A more diversified sample could help to provide a
more comprehensive picture about earnings management used by Chinese firms in
response to the GFC. Secondly, the GFC started since 2008 had lasted for few years,
it may take longer time for firms to react to it. The sample period in this study may be
inevitably not long enough. Therefore, in the future, the research could be extended in
these aspects.
References
Ahmed, K and Saleh N, M, 2005, Earnings management of distressed firms during
debt renegotiation, International Journal of Accounting, Auditing and Performance
evaluation, 4, 6, 589-607
Charoenwong, C. and Jiraporn, P., 2009, Earnings management to exceed
thresholds: evidence from Singapore and Thailand, Journal of Multinational
Financial Management, 19, 3, 221-236
Chia, Y.M., Lapsley, I. and Lee, H.W., 2007, Choice of auditors and earnings
management during the Asian financial crisis, Managerial Auditing Journal, 22, 2,
177-196
Cohen, D.A. and Zarowin, P., 2010, Accrual-based and real earnings management
activities around seasoned equity offerings, Journal of Accounting and
Economics, volume 50, 2-19
DeAngelo, H., DeAngelo, L. and Skinner, D., 1994, Accounting choices of troubled
companies, Journal of Accounting and Economics, 17, 113-143
Defond, M.L. and Jiambalvo, J., 1994, Debt Covenant Violation and Manipulation of
Accruals, Journal of Accounting and Economics, 17, 145-176
Godfrey, J., Mather, P. and Ramsay, A., 2003, Earnings and Impression management
in Financial Reports: The case of CEO changes, Abacus 39, 95-123
Guidry, F., Leone, A. and Rock, S., 1998, Earnings-based bonus plans and earnings
management by business-unit managers, Journal of Accounting and Economics,
26, 113-142
Proceedings of Annual Shanghai Business, Economics and Finance Conference
3 - 4 November 2014, Shanghai University of International Business and Economics, Shanghai, China
ISBN: 978-1-922069-63-4
Healy, P.M., 1985, the Effect of Bonus Schemes on Accounting Decisions, Journal of
Accounting and Economics, 7, 85-107
Healy, P.M. and Wahlen, J.M., 1999, A Review of the Earnings Management
Literature and Its Implications for Standard Setting, Accounting Horizons, 13, 4,
365-383
Kim, Y. and Yi, C.H., 2006, Ownership Structure, Business Group Affiliation, Listing
Status, and Earnings Management: Evidence from Korea, Canadian Academic
Accounting Association, Contemporary Accounting Research, 23, 2, 427-464
Koh, K., Matsumoto, D. and Rajgopal, S., 2008, Meeting or Beating Analyst
Expectations in the Post-Scandals World: Changes in Stock Market Rewards and
Managerial Actions, Contemporary Accounting Research, 25, Issue 4, 1067-1098
Kothari, S.P., Leone, A.J. and Wasley, C.E., 2005, Performance matched
discretionary accrual measures, Journal of Accounting and Economics, 39, 163–
197
Li, S. F., McDowell, E., and Moore, E. A., 2008, Accrual Based Earnings Management,
Real Transactions Manipulation and Expectations Management: U.S. and
International Evidence, Journal of Global Business Management, 4 (2)
McNichols, M., and Wilson, G.P., 1988, Evidence of Earnings Management from the
Provision from Bad Debts, Journal of Accounting Research, 26, 1-31
Roychowdhury, S., 2006, Earnings management through real activities manipulation,
Journal of Accounting and Economics, 42, 335–370
Scott, W.R., 2009, Financial accounting theory, 5th edition, chapter 11.
Shuto, A., 2007, Executive compensation and earnings management: Empirical
evidence from Japan, Journal of international Accounting, Auditing and Taxation,
16, 1-26
Teoh, S.H., Welch, I. and Wong, T.J., 1998, Earnings management and the long-run
market performance of Initial Public Offerings, The Journal of Finance, 53, 6,
1935-1974
Watts, R.L., 1977, Corporate finance statements, a product of the market and political
processes, Australian Journal of Management, April, 53-75
Watts, R.L. and Zimmerman, J., 1978, Towards a positive theory of the determination
of Accounting standards, Accounting Review, Jan. 112-134
Wong, J., 1988, Political costs and an intra-period accounting choice for export tax
credits, Journal of Accounting and Economics, 10, 1, 37-51
Yu, Y., 2009, China’s reaction to the global economic crisis, Research institute of
Economy, Trade and Industry report, number 112