Propping through related party transactions
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Based on a sample of Chinese listed firms from 1998 through 2002, this paper documents that listed firms prop up earnings by using abnormal related sales to their controlling owners. Such related sales propping is more prevalent among state-owned firms and in regions with weaker economic institutions. We also find that these abnormal related sales are not entirely accrual-based but can be cash-based as well, and they serve as a substitute rather than complement to accruals management for meeting earnings targets. Since these abnormal related sales can be cash-based, there is significant cash transfer via related lending from listed firms back to controlling owners after the propping. However, no cash transfer via related lending is found to be associated with accruals earnings management.
KeywordsPropping Related party transactions Corporate governance Controlling shareholders
JEL ClassificationsG3 M4
This paper, previously titled “Earnings Management and Tunneling through Related Party Transactions: Evidence from Chinese Corporate Groups”, has benefited from discussions with seminar participants at the Chinese University of Hong Kong, the Hong Kong University of Science and Technology, Nanyang Technological University of Singapore, Shanghai University of Finance and Economics, the University of Hong Kong, the 2003 European Finance Association Conference, the 2004 Asian Finance Association Meeting, the 2004 American Accounting Association Annual Meeting, and the 2005–2006 Global Issues in Accounting Conference at University of North Carolina—Chapel Hill. We especially appreciate comments from Kee-Hong Bae, Robert Bushman, Kalok Chan, Kevin Chen, Joseph Fan, Chul Park, Joseph Piostroski, Gordon Richardson, Woody Wu, and Tianyu Zhang. Any errors are our own. We thank Tianyu Zhang for providing the pyramid data. We also acknowledge the financial support of the Direct Allocation Grant at the Chinese University of Hong Kong and Singapore Ministry of Education Academic Research Fund Tier 1, Grant number of project SUG 1/04.
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