Accrual-Based Earnings Management and Corporate Governance--China Evidence in the Pre- and Post-Code Periods

This thesis aims to investigate the impact of implementation of The Code of Corporate Governance . for Listed Companies in China (or the Code) in 2002 upon the accrual-based earnings management (hereafter EM) practices in China's listed companies. Based on Transaction Cost Economics (TCE) and Agency Theory (AT), it is hypothesised that, due to the improvement of the corporate governance Code, Chinese listed companies engage less in EM. In particular, it is hypothesised the relationships between the main corporate governance (or CG) mechanisms arranged from the executive compensation to the characteristics of controlling shareholders (shareholdings and ownership type) and EM prior to and after the Code. Drawing upon a panel data of 447 non-financial Chinese listed companies over the period of 2000-2006, the results provide robust evidence suggesting that while the magnitude of discretionary accruals (or DAs-proxy of EM) measured by the Modified Jones Model (Dechow el al., 1995) and the Larcker and Richardson (2004) (or L&R) Model respectively decreases over time, the reduction is more pronounced after the Code compared with it prior to the Code. In addition, the findings show that companies engage in larger earning-decreasing DAs are followed by smaller positive reversals. The findings also document that: (1) the performance-based compensation is neither statistically nor economically related to the magnitude of DAs; (2) the independent non-executives on the board significantly constrain the magnitude of DAs, and such effect is increased significantly in the post-Code period; (3) while both the audit committee and the institutional investors significantly reduce earnings-increasing DAs, especially in the post-Code period, they do not significantly mitigate the earnings-decreasing choices; (4) the use of the international reputable auditor (Big 4) is not significantly correlated to the magnitude of DAs; and (5) the controlling shareholders especially who are ultimately controlled by the State significantly engage in DAs before and after the Code. This thesis has made important theoretical and managerial implications. Theoretically, it implies that as TCE and AT are complementary theories, a theoretical framework by incorporating TCE with AT should be robust in investigating the relationships between CG and EM in China's stock markets. Managerially, it implies that investors should be aware of the EM behaviours and need to check firms' financial statements with great caution. For stock market regulators, they may need to: (1) enforce more transparent compliance with the CG Code, and extend the requirements and duties of non-executives so that greater oversight is provided; (2) strengthen the independence and expertise of the audit committee; and (3) be cautious of promoting the participation of international audit firms as these firms do not necessarily help China with improving its monitoring system. For policy makers, they may need to consider improving the legal environment so as to make expropriation of minority shareholders more difficult. Declaration of Originality I hereby declare that this thesis entitled "Accrual-Based Earnings Management and Corporate Governance-China Evidence in the Preand Post-Code periods" has been composed by myself and has not been presented or accepted in any previous application for a degree. The work, of which this is a record, has been carried out by myself unless otherwise stated and where the work is mine, it reflects personal views and values. All quotations have been distinguished by quotation marks and all sources of information have been acknowledged by means of references including those of the Internet. Table of