The impact of the Chinese stimulus program on earnings management

• Date: 07 October 2019
• Pages: 653-670
• Published date: 07 October 2019
• DOI: https://doi.org/10.1108/IJAIM-11-2018-0134
• Author: Qian Hao,Xiangyan Shi,Danlu Bu,Liaoliao Li

The impact of the Chinese

stimulus program on

earnings management

Qian Hao

Kutztown University of Pennsylvania, Kutztown, Pennsylvania, USA

Xiangyan Shi and Danlu Bu

Southwestern University of Finance and Economics, Chengdu, China, and

Liaoliao Li

Kutztown University of Pennsylvania, Kutztown, Pennsylvania, USA

Abstract

Purpose –The purpose of thispaper is to investigate the impacts of the 2008 Chinesestimulus program on

earningsmanagement.

Design/methodology/approach –Using a sample periodfrom 2004 to 2011 (per-stimulus period: 2004-

2007 and post-stimulusperiod: 2008-2011), the authors compare the change in earnings managementbetween

the firms that receivedthe stimulus funds and those that did not receive the stimulus funds.

Findings –The authors find that from the pre- to post-stimulus period, the recipient firms experienced a

greater increase in downwardaccrual management and a greater decrease in real managementthan the non-

recipient firms did. This result is primarily driven by the non-state-owned enterprises and firms using non-

Big-Fourauditors.

Originality/value –The results suggest that the earningsmanagement level is ultimately determined by

the underlying economic and political factors influencing managers’and auditors’incentives (Cohen, 2008;

Ball et al.,2003). Meanwhile, some mechanisms, such as high-quality audit (Eshleman and Guo, 2014) and

state ownership(Wang and Yung, 2011) can also play a role in determiningthe level of earnings management.

Keywords Accrual management, Real management, Stimulus programme

Paper type Research paper

Introduction

This paper studies the effects of the 2008 Chinese stimulus program on firms’earnings

management. This stimulus package was to inject 4tn Renminbi (RMB) (equivalent to US

$586bn, about 12.5 per cent of the 2008 ChineseGDP) into the economy from November 2008

until the end of 2010. Although some papers study the effects of the stimulus on economy

(Naughton, 2009), very few examine itsimpact on earnings management. It is interesting to

investigate the implications of such an enormous government stimulus on managers’

incentives to manipulateearnings and therefore the firms’earningsmanagement level.

Prior research explains earnings management from capital market perspective and

contract perspective (Healyand Wahlen, 1999). Managers are more likely to inflate earnings

before they issue equity or debt (Hirshleifer et al.,2004). By reporting good accounting

performance, managers can attract capital providers and get better terms. On the other

hand, both debt contract and managerial compensation contract are written in accounting

numbers. To avoid debt contract violation, managers use accountingmethods to help them

abide by the contract (Demerjian,2011). Managers are also motivated to increase earnings to

Earnings

management

653

Received6 November 2018

Revised12 April 2019

28April 2019

6 May2019

Accepted26 May 2019

InternationalJournal of

Accounting& Information

Management

Vol.27 No. 4, 2019

pp. 653-670

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-11-2018-0134

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

enhance their personal compensation, which usually is tied to accounting earnings. We

argue that the 2008 stimulus program reduced the need to finance from the capital market

and decreased the importance of debt covenantin monitoring the performance of the lender.

Consequently, the firms that received the stimulus supports (hereafter recipient firms) are

less likely to manage earnings upward than the firms that did not receive the stimulus

supports (hereafternon-recipient firms).

The empirical results are consistent with our hypotheses. We find that from the pre- to

post-stimulus period, the recipientfirms experienced a greater decrease in real management

than the non-recipient firms did. Meanwhile,we find that the recipient firms are more likely

to engage in downward accrual management than the non-recipient firms did in the post-

stimulus period.

This paper contributes to the literature in several ways. First, to the best of our

knowledge, this is the first paper to study the effects of the government stimulus program

on earnings management. Hao et al. (2018) examined the effects of the stimulus on

accounting information quality in general. Second, it studiesboth accrual management and

real management. The literature suggests the firms’use of real and accrual earnings

management around important corporate events varies, depending on their ability to use

and the relative costs of each type of management (Zang, 2012;Rangan, 1998;Cohen and

Zarowin, 2010). This paper corroborates this conclusion by documenting an increase in

downward accrual management and a decrease in real management for the recipient firms

during the stimulus period when there is a change in the relative benefits/costs between

different tools of earnings management.Third, recent research advances our understanding

of the effects of the political costs, in particular, state ownership on accounting practices in

China (Wang and Yung, 2011). This paper extendsthis literature by providing another piece

of evidence that the ownership structureplays a role in determining the managers’reporting

incentives. Last but not least, this paper substantiates the priorliterature that the Big-Four

auditors provide high-quality audit consistently. We find that the earnings quality of the

recipient firms using Big-Four auditors is stable, without much variation between the pre-

and post-stimulus periods. In contrast,in the post-stimulus period, the recipient firms using

non-Big-Four auditors exhibitedmore income-decreasing accrual management and less real

management, suggesting that non-Big-Four auditors play a limited role in mitigating the

incentives to manipulateearnings to the managers’favor.

The remainder of the paper proceeds as follows. Section 2 reviews the literature and

develops the main hypotheses. Section 3 describes the research methodology. Section 4

describes the sample-selection process and the data. Empirical results are presented in

Section 5. Finally,we conclude the paper in Section 6.

2. Literature review and hypotheses development

2.1 Motives for earnings management

Healy and Wahlen (1999) suggested two motivations for earnings management. One is

capital market perspective and the other is contracts perspective. In a market economy,

managers considering profitable investment projects but facing financing constraints can

issue equity or debt to acquire the needed capital. Managers, therefore, are motivated to

manipulate earnings to impress capital providers with favorable accounting numbers to

obtain financing more easilyand on better terms (Hirshleiferet al.,2004;Lee and Choi, 2016).

Empirical research documents that managers tend to report positive (income-increasing)

accruals before the capital issuancedate (Shivakumar, 2000;Gaud et al., 2007).

Accounting data are also used to help monitor and regulate the contracts between the

firm and its stakeholders (Healy and Wahlen, 1999).Lending contracts usually use a variety

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