Analyst following, disclosure quality, and discretionary impairments: Evidence from China

• Published date: 01 October 2020
• Author: Ling Jiang
• Date: 01 October 2020
• DOI: http://doi.org/10.1111/jifm.12120

J Int Financ Manage Account. 2020;31:295–322.

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295

wileyonlinelibrary.com/journal/jifm

Received: 6 August 2019

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Revised: 9 July 2020

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Accepted: 20 July 2020

DOI: 10.1111/jifm.12120

ORIGINAL ARTICLE

Analyst following, disclosure quality, and

discretionary impairments: Evidence from China

LingJiang

© 2020 John Wiley & Sons Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

School of Accounting, Jiangxi University

of Finance and Economics, Nanchang,

China

Correspondence

Ling Jiang, School of Accounting, Jiangxi

University of Finance and Economics,

Nanchang, China.

Email: jiangling@jxufe.edu.cn

Funding information

Jiangxi University of Finance and

Economics

Abstract

Financial statement preparers’ discretion in fair value meas-

urements is integral to asset impairment accounting. Firms

may misuse this discretion to report more or less impair-

ment loss than is warranted by underlying economic circum-

stances. Using data from a sample of publicly listed firms

in China, this study finds that analyst following reduces

abnormal impairment loss, the portion of reported impair-

ment loss that cannot be explained by corporate economic

circumstances and that this effect is more pronounced for

firms with lower information disclosure quality. However,

the reducing effects of analyst following and its interaction

with disclosure quality are greater for income-decreasing

than for income-increasing abnormal impairment loss.

Additional analyses support the argument that these dif-

ferences are attributable to the dominance of accounting’s

contracting role over its informational role. Overall, the

findings indicate that the influence of analyst following on

discretionary impairment accounting decisions is moder-

ated by disclosure quality and by the relative importance

of accounting’s contracting and informational roles in an

emerging market setting.

KEYWORDS

accounting discretion, analyst, disclosure quality, fair value

accounting, impairments

JEL CLASSIFICATIONS

G34; M41; D81

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JIANG

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INTRODUCTION

This study examines in an emerging market setting how the influence of analyst following on the

discretionary fair-value-based impairment accounting is moderated by particular conditions, includ-

ing the firm’s information opacity, the informational and contracting roles of accounting, and related

management reporting incentives. The fair value estimation problem is likely exacerbated in emerging

markets due to the insufficiency of market information for fair value measurement (He, Wong, &

Young, 2012; Landsman, 2007). The coefficient of variation (standard deviation divided by the abso-

lute value of the mean) of pre-impairment earnings divided by reported impairment loss is 71.735 for

the sample observations, while the coefficient of variation, computed from the descriptive statistics of

comparable numbers in a previous study (Spear & Taylor, 2011) based on US data, is 14.367. Opacity

is a factor relevant to the quality of fair value accounting information such as impairments since the

related decisions involve considerable management discretion, and the decision process is unknown

to corporate outsiders. Prior studies (Cang, Chu, & Lin, 2014; Piotroski & Wong, 2013) suggest that

China’s capital market information environment is more opaque than that of developed markets. This

provides a valuable setting to examine how opacity moderates the effect of analyst following on dis-

cretionary impairments.

Analysts provide external verification of company-provided information, reduce information

asymmetry between investors and firms, and increase corporate visibility (Chen, Harford, & Lin,

2015; Fama, 1980; Jensen & Meckling, 1976; Yu, 2008). In China, increased analyst following also

helps to enhance the integrity of fair-value-based impairment accounting decisions since analysts

may occasionally obtain information unavailable to the general investing public, through communi-

cation and interactions with firms and their network ties with firms and other analysts (Li, Wong, &

Yu, 2019). Such information may be useful for assessing discretionary decisions involving fair value

measurements. Furthermore, analysts may also counteract other analysts’ potential biases (Jia, Ritter,

Xie, & Zhang, 2018) through independent analyses and professional judgments. Nevertheless, some

studies (Burgstahler & Eames, 2006; Degeorge, Patel, & Zeckhauser, 1999) suggest that analyst fol-

lowing could stimulate manipulations in discretionary accounting decisions.

Cang et al. (2014) find that analyst following curbs earnings management in separately listed and

thus less opaque income-statement items and stimulates earnings management in aggregated and thus

more opaque income-statement items in China. These findings suggest that analyst following could

stimulate manipulations in the opaque impairment accounting process, especially for more opaque

firms. By contrast, the finding of other studies (Irani & Oesch, 2013; Knyazeva, 2007; Sun, 2009)

that analyst following remedies weaknesses in other mechanisms suggests the opposite prediction.

Furthermore, research (He et al., 2012) finds that the implementation of fair value accounting in

China has led to unintended consequences attributable to the dominance of accounting’s contracting

role over its informational role. While the informational role of accounting is becoming increasingly

important in China as the capital market develops, its contracting role has been a traditional part of

and fundamental to economic activities. Since no clear prediction can be made based on prior research

findings, this study empirically examines in an emerging market setting whether analyst following

enhances the quality of impairment accounting information, whether this effect differs across firms

with different levels of information opacity, and whether these effects are affected by the relative im-

portance of accounting’s contracting and informational roles.

The quality of impairment accounting information is examined in terms of how well the reported

impairment loss reflects its underlying economic substance. This is measured by the absolute value

of the residual from a regression of reported impairment loss on a set of impairment indicators. The

residual has a positive value when the reported impairment loss amount is greater than that predicted