Skip to main content
SpringerLink
Log in

Regional Legal Protection and Earnings Management: Evidence from China

  • Chapter
  • First Online:
Corporate Governance in Emerging Markets

Part of the book series: CSR, Sustainability, Ethics & Governance ((CSEG))

Abstract

This chapter investigates the impact of regional legal protection on the earnings management of Chinese companies. Chinese data provide a time-variant legal protection index, which is advantageous in controlling for time-invariant, non-legal characteristics. We find that regional legal protection reduces earnings management for the period before the implementation of Split-share Structure Reform. The result is consistent with the conventional wisdom that better legal environments are associated with better earnings quality. Further analyses suggest that a significant relation exists especially between the protection of intellectual property rights and earnings management. This result proposes that legal protection mitigates earnings management that aims to prevent technology spillovers. However, there is no evidence that regional legal protection affects earnings management during the Split-share Structure Reform and after the adoption of IFRS-convergent New Accounting Standards.

This is a preview of subscription content, log in via an institution to check access.

Access this chapter

Log in via an institution
Chapter
USD 29.95
Price excludes VAT (USA)
  • Available as PDF
  • Read on any device
  • Instant download
  • Own it forever
eBook
USD 129.00
Price excludes VAT (USA)
  • Available as EPUB and PDF
  • Read on any device
  • Instant download
  • Own it forever
Softcover Book
USD 169.99
Price excludes VAT (USA)
  • Compact, lightweight edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info
Hardcover Book
USD 169.99
Price excludes VAT (USA)
  • Durable hardcover edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info

Tax calculation will be finalised at checkout

Purchases are for personal use only

Institutional subscriptions

Notes

  1. 1.

    Industry classification is based on the Classification Guidance of Chinese Listed Companies (1998), issued by CSRC.

  2. 2.

    Another feature in Chinese corporate governance is the existence of listed companies that are controlled by the governments. The governments are likely to pursue social and political objectives (e.g., employment, tax or social welfare) rather than shareholder value maximization (Liu and Lu 2007). As a result, firms controlled by the governments are likely to engender expropriation problems and to engage in earnings management. We do not explicitly address the issue, since the effect of state control is incorporated in firm-fixed effects.

  3. 3.

    All board members who hold at least one share are counted in the numerator of this variable.

  4. 4.

    This guideline prohibits the manager, directors and financial officers of the company from being members of a supervisory board.

  5. 5.

    The Code of Corporate Governance for Listed Companies allows the board of supervisors to report directly to regulatory authorities if it finds any violations of laws, regulations, accounting standards or firm charters.

  6. 6.

    All supervisory members who own at least one share are counted in the numerator of this variable.

  7. 7.

    The Guidance for Establishing Independent Directors System for Listed Companies, issued by the CSRC in 2001, required Chinese listed companies to gradually establish an independent directors system and to make qualified independent directors account for at least one-third of board members.

  8. 8.

    The Hausman test results (unreported) suggest adoption of a fixed-effects model rather than a random-effects model.

References

  • Ahmed, K., Hossain, M., & Adams, M. (2006). The effects of board composition and board size on the informativeness of annual accounting earnings. Corporate Governance: An International Review, 14, 418–431.

    Article  Google Scholar 

  • Atiase, R. (1985). Predisclosure information, firm capitalization, and security price behavior around earnings announcements. Journal of Accounting Research, 23, 21–36.

    Article  Google Scholar 

  • Beasley, M. (1996). An empirical analysis between the board of director composition and financial statement fraud. The Accounting Review, 71, 443–466.

    Google Scholar 

  • Beaver, W., Kettler, P., & Scholes, M. (1970). The association between market determined and accounting determined risk measures. The Accounting Review, 45, 654–682.

    Google Scholar 

  • Breeden, R. (1994). Foreign companies and U.S. markets in a time of economic transformation. Fordham International Law Journal, 17, S77–S96.

    Google Scholar 

  • Burgstahler, D. C., Hail, L., & Leuz, C. (2006). The importance of reporting incentives: Earnings management in European private and public firms. The Accounting Review, 81, 983–1016.

    Article  Google Scholar 

  • Butler, M., Leone, A. J., & Willenborg, M. (2004). An empirical analysis of auditor reporting and its association with abnormal accruals. Journal of Accounting and Economics, 37, 139–165.

    Article  Google Scholar 

  • Chen, G. M., Firth, M., Gao, D. N., & Rui, O. M. (2006). Ownership structure, corporate governance, and fraud: Evidence from China. Journal of Corporate Finance, 12, 424–448.

    Article  Google Scholar 

  • Chen, G. M., Firth, M., & Xu, L. P. (2009). Does the type of ownership control matter? Evidence from China’s listed companies. Journal of Banking and Finance, 33, 171–181.

    Article  Google Scholar 

  • Claessens, S., Djankov, S., & Lang, L. H. P. (2000). The separation of ownership and control in East Asian corporations. Journal of Financial Economics, 58, 81–112.

    Article  Google Scholar 

  • Claessens, S., Djankov, S., Fan, J., & Lang, L. (2002). Disentangling the incentive and entrenchment effects of large shareholdings. Journal of Finance, 57, 2741–2772.

    Article  Google Scholar 

  • Claessens, S., Djankov, S., & Klapper, L. (2003). Resolution of corporate distress in East Asia. Journal of Empirical Finance, 10, 199–216.

    Article  Google Scholar 

  • Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1995). Detecting earnings management. The Accounting Review, 70, 193–225.

    Google Scholar 

  • Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1996). Causes and consequences of earnings manipulation: An analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research, 13, 1–36.

    Article  Google Scholar 

  • Dechow, P. M., Ge, W. L., & Schrand, C. (2010). Understanding earnings quality: A review of the proxies, their determinants and their consequences. Journal of Accounting and Economics, 50, 344–401.

    Article  Google Scholar 

  • Dhaliwal, D., Lee, K., & Fargher, N. (1991). The association between unexpected earnings and abnormal security returns in the presence of financial leverage. Contemporary Accounting Research, 8, 20–41.

    Article  Google Scholar 

  • Dimitropoulos, P. E., & Asteriou, D. (2010). The effect of board composition on the informativeness and quality of annual earnings: Empirical evidence from Greece. Research in International Business and Finance, 24, 190–205.

    Article  Google Scholar 

  • Doidge, C., Karolyi, A., & Stulz, R. (2004). Why are foreign firms listed in the US worth more? Journal of Financial Economics, 71, 205–238.

    Article  Google Scholar 

  • Dyck, A., & Zingales, L. (2004). Private benefits of control: An international comparison. Journal of Finance, 59, 537–599.

    Article  Google Scholar 

  • Fan, G., & Wang, X. L. (2011). NERI index of marketization of China’s provinces. Beijing: Economic Science Press (In Chinese).

    Google Scholar 

  • Fan, J. P. H., & Wong, T. J. (2002). Corporate ownership structure and the informativeness of accounting earnings in East Asia. Journal of Accounting and Economics, 33, 401–425.

    Article  Google Scholar 

  • Fan, J. P. H., Gillan, S. L., & Yu, X. (2013). Property rights, R&D spillovers, and corporate accounting transparency in China. Emerging Markets Review, 15, 34–56.

    Article  Google Scholar 

  • Firth, M., Fung, P. M. Y., & Rui, O. M. (2007). Ownership, two-tier board structure, and the informativeness of earnings: Evidence from China. Journal of Accounting and Public Policy, 26, 463–496.

    Article  Google Scholar 

  • Firth, M., Lin, C., Liu, P., & Wong, S. M. L. (2009). Inside the black box: Bank credit allocation in China’s private sector. Journal of Banking and Finance, 33, 1144–1155.

    Article  Google Scholar 

  • Forker, J. J. (1992). Corporate governance and disclosure quality. Accounting and Business Research, 22, 111–124.

    Article  Google Scholar 

  • Freeman, R. (1987). The association between accounting earnings and security returns for large and small firms. Journal of Accounting and Economics, 9, 195–228.

    Article  Google Scholar 

  • Haw, I., Hu, B., Hwang, L., & Wu, W. (2004). Ultimate ownership, income management, and legal and extra-legal institutions. Journal of Accounting Research, 42, 423–462.

    Article  Google Scholar 

  • He, X. J., Wong, T. J., & Young, D. Q. (2012). Challenges for implementation of fair value accounting in emerging markets: Evidence from China. Contemporary Accounting Research, 29, 538–562.

    Article  Google Scholar 

  • Holderness, C. G. (2008). Do differences in legal protections explain differences in ownership concentration? Working Paper, Boston College.

    Google Scholar 

  • Holland, K., & Jackson, R. H. G. (2004). Earnings management and deferred tax. Accounting and Business Research, 34, 101–123.

    Article  Google Scholar 

  • Jensen, M. C. (1993). The modern industrial revolution, exit, and the failure of internal control systems. Journal of Finance, 48, 830–881.

    Article  Google Scholar 

  • Jiang, H. Y., & Habib, A. (2012). Split-share reform and earnings management: Evidence from China. Advances in Accounting, incorporating Advances in International Accounting, 28, 120–127.

    Google Scholar 

  • Jin, H., Qian, Y., & Weingast, B. (2005). Regional decentralization and fiscal incentives: Federalism, Chinese style. Journal of Public Economics, 89, 1719–1742.

    Article  Google Scholar 

  • Johnson, S., La Porta, R., Lopez-De-Salinas, F., & Shleifer, A. (2000). Tunneling. American Economic Review, 90, 22–27.

    Article  Google Scholar 

  • Kali, R. (1999). Endogenous business networks. Journal of Law, Economics, and Organization, 15, 615–636.

    Article  Google Scholar 

  • Klein, A. (2002). Audit committee, board of director characteristics, and earnings management. Journal of Accounting and Economics, 33, 375–400.

    Article  Google Scholar 

  • Kothari, S. P., Leone, A. J., & Wasley, C. E. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39, 163–197.

    Article  Google Scholar 

  • La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (1998). Law and finance. Journal of Political Economy, 106, 1113–1155.

    Article  Google Scholar 

  • La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (1999). Corporate ownership around the world. Journal of Finance, 54, 471–518.

    Article  Google Scholar 

  • La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (2000). Agency problems and dividend policies around the world. Journal of Finance, 55, 1–33.

    Article  Google Scholar 

  • Lang, M., Raedy, J. S., & Wilson, W. (2006). Earnings management and cross listing: Are reconciled earnings comparable to US earnings? Journal of Accounting and Economics, 42, 255–283.

    Article  Google Scholar 

  • Leuz, C., Nanda, D., & Wysocki, P. D. (2003). Earnings management and investor protection: An international comparison. Journal of Financial Economics, 69, 505–527.

    Article  Google Scholar 

  • Liu, Q., & Lu, Z. (2007). Corporate governance and earnings management in the Chinese listed companies: A tunneling perspective. Journal of Corporate Finance, 13, 881–906.

    Article  Google Scholar 

  • Liu, C. H., Yao, L. J., Hu, N., & Liu, L. (2011). The impact of IFRS on accounting quality in a regulated market: An empirical study of China. Journal of Accounting, Auditing and Finance, 26, 659–676.

    Article  Google Scholar 

  • Lo, A. W. Y., Wong, R. M. K., & Firth, M. (2010). Can corporate governance deter management from manipulating earnings? Evidence from related-party sales transactions in China. Journal of Corporate Finance, 16, 225–235.

    Article  Google Scholar 

  • MacNeil, I. (2002). Adaptation and convergence in corporate governance: The case of Chinese listed companies. Journal of Corporate Law Studies, 2, 289–344.

    Google Scholar 

  • Minton, B., & Schrand, C. (1999). The impact of cash flow volatility on discretionary investment and the costs of debt and equity financing. Journal of Financial Economics, 54, 423–460.

    Article  Google Scholar 

  • Mintz, S. M. (2005). Corporate governance in an international context: Legal systems, financing patterns, and cultural variables. Corporate Governance: An International Review, 13, 582–597.

    Article  Google Scholar 

  • Park, Y. W., & Shin, H. H. (2004). Board composition and earnings management in Canada. Journal of Corporate Finance, 10, 431–457.

    Article  Google Scholar 

  • Peasnell, K., Pope, P., & Young, S. (2005). Board monitoring and earnings management: Do outside directors influence abnormal accruals. Journal of Business Finance and Accounting, 32, 1311–1346.

    Article  Google Scholar 

  • Qian, Y., & Weingast, B. (1997). Federalism as a commitment to preserving market incentives. Journal of Economic Perspectives, 11, 83–92.

    Article  Google Scholar 

  • Raheja, C. (2005). Determinants of board size and composition: A theory of corporate boards. Journal of Financial and Quantitative Analysis, 40, 283–306.

    Article  Google Scholar 

  • Shen, C. H., & Chih, H. L. (2005). Investor protection, prospect theory, and earnings management: An international comparison of the banking industry. Journal of Banking and Finance, 29, 2675–2697.

    Article  Google Scholar 

  • Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. Journal of Finance, 52, 737–775.

    Article  Google Scholar 

  • Vafeas, N. (2000). Board structure and the informativeness of earnings. Journal of Accounting and Public Policy, 19, 139–160.

    Article  Google Scholar 

  • Wang, H. C., Liu, T. L., & Lu, C. (2007). Corporate governance and earnings quality: Evidence from China. China Soft Science, 11, 122–128 (In Chinese).

    Google Scholar 

  • Watts, R. L., & Zimmerman, J. L. (1978). Towards a positive theory of the determination of accounting standards. The Accounting Review, 53, 112–134.

    Google Scholar 

  • Watts, R. L., & Zimmerman, J. L. (1990). Positive accounting theory: A ten year perspective. The Accounting Review, 56, 131–156.

    Google Scholar 

  • Wu, S. N., Xu, N. H., & Yuan, Q. B. (2009). State control, legal investor protection, and ownership concentration: Evidence from China. Corporate Governance: An International Review, 17, 176–192.

    Article  Google Scholar 

  • Xie, B., Davidson, W. N., & DaDalt, P. J. (2003). Earnings management and corporate governance: The role of the board and the audit committee. Journal of Corporate Finance, 9, 295–316.

    Article  Google Scholar 

  • Zhang, Y., Uchida, K., & Bu, H. (2013). How do accounting standards and insiders’ incentives affect earnings management? Evidence from China. Emerging Markets Review, 16, 78–99.

    Google Scholar 

  • Zingales, L. (1994). The value of the voting right: A study of the Milan stock exchange experience. Review of Financial Studies, 7, 125–148.

    Article  Google Scholar 

Download references

Acknowledgements

We would like to thank the financial support provided by the JSPS KAKENHI Grant Number 23330107.

Author information

Authors and Affiliations

  1. Graduate School of Economics, Kyushu University, 6-19-1, Hakozaki, Higashiku, Fukuoka, 812-8581, Japan

    Yuyang Zhang

  2. Faculty of Economics, Kyushu University, 6-19-1, Hakozaki, Higashiku, Fukuoka, 812-8581, Japan

    Konari Uchida

  3. School of Management, China University of Mining and Technology, University Road, Xuzhou, Jiangsu Province, 221116, China

    Hua Bu

Authors
  1. Yuyang Zhang
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Konari Uchida
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Hua Bu
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Konari Uchida .

Editor information

Editors and Affiliations

  1. Department of Accounting and Finance, Champagne School of Management (Groupe ESC Troyes en Champagne), Troyes, France

    Sabri Boubaker

  2. IPAG Research Lab, IPAG Business School, Paris, France

    Duc Khuong Nguyen

Rights and permissions

Reprints and permissions

Copyright information

© 2014 Springer-Verlag Berlin Heidelberg

About this chapter

Cite this chapter

Zhang, Y., Uchida, K., Bu, H. (2014). Regional Legal Protection and Earnings Management: Evidence from China. In: Boubaker, S., Nguyen, D. (eds) Corporate Governance in Emerging Markets. CSR, Sustainability, Ethics & Governance. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-44955-0_6

Download citation

Publish with us

Policies and ethics

Search

Navigation