Quality of reported earnings by Chinese firms: The influence of ownership structure

a r t i c l e i n f o This paper examines the influence of ownership structure on earnings quality of firms listed on the Chinese Stock Exchanges. We empirically test four contemporary earnings quality measures, including volatility of earnings, variability of earnings over cash flows, correlations between accruals and cash flows, and level of discretionary accruals, for 1438 firms listed on Shenzhen Stock Exchange and Shanghai Stock Exchange. We find that although state-owned firms are bigger in size and appear more profitable based on reported earnings; privately-owned firms, foreign-owned firms and society-owned firms outperform the state-controlled firms in earnings quality; and foreign-owned firms have the highest earnings quality among all types of ownership groups. We find that there is not much difference in earnings quality between collectively-owned firms and state-owned firms and employee-owned firms exercise least discretion in earnings management. The findings in particular will have direct policy implications for the China Securities Regulatory Committee (CSRC). The economy of China has undergone a significant transformation in the last three decades. Industries have been reorganized and corporations and many state owned enterprises have been partially or totally privatized. Chen, Firth, and Rui (2006) investigated the impact of the effectiveness of the privatizations on firms' operating efficiency and performance. They found an overall decline in efficiency and asset utilization in the 5 years after privatization. This finding is in stark contrast to similar studies from other countries where the results show a marked improvement in both profitability and efficiency. Some studies suggested that part of the reason for poor profitability could be due to the state retaining control in some companies. However, Chen, Firth, and Xu (2009) stated that these studies fail to properly identify and distinguish among the different types of owners or ownership structures. Chen et al. (2009) found that operating efficiency was a function of who controls the firm after its listing. In particular, when private investors control the firm, there is a marked improvement in efficiency relative to when the firm is state controlled. Jensen and Meckling (1976) argued that when private investors manage the business there is an incentive for them to increase the " wealth " of the firm. Is this wealth " increase " real or manipulated? This issue has not been examined with respect to Chinese firms. However, this is important because China currently attracts significant amounts of capital from western …