Politically connected CEOs and earnings management: evidence from China

ABSTRACT

This paper examines the impact of politically connected CEOs on earnings management in Chinese listed firms. The results show that firms with politically connected CEOs engage in significantly lower levels of accrual-based earnings management than firms without politically connected CEOs. We then find evidence that firms with politically connected CEOs conduct significantly higher levels of real earnings management, which is more difficult to detect than accrual-based earnings management, and that in non-state-controlled firms, where government support is less, the presence of politically connected CEOs is positively related to accruals manipulation. We draw regulators’ attention to the fact that using accrual-based earnings management measures alone may underestimate the earnings management activities of firms with politically connected CEOs. Our findings are robust after controlling for possible endogeneity.

KEYWORDS:

• Politically connected CEOs
• earnings management
• China

JEL CODES:

• G34
• G38

Acknowledgements

We are grateful for valuable comments from Dr Gary Tian and participants at the 27th CESA annual conference in Wollongong. We appreciate the helpful comments made by Andrea Bennett. We also wish to thank participants in a Massey University seminar for their helpful comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. The Chinese Securities Regulatory Commission (CSRC) is the regulatory body in China which is in charge of approving Initial Public Offerings (IPOs), Seasoned Equity Offerings (SEOs) or firm delisting, and these decisions are primarily based on accounting performance.

2. As in Cheng and Leung (2012), we check the background of the board chairpersons instead of the chief executive officers (CEOs) or the general managers (please see Section 3.2 for detailed justifications). In Fan, Wong, and Zhang (2007), politically connected CEOs include both politically connected CEOs and directors of the boards. We believe that the difference in the percentage of politically connected CEOs between our paper (22.36%) and the one reported in Fan, Wong, and Zhang (2007) (27%) is due to two reasons. First, the sample period in Fan, Wong, and Zhang (2007) is from 1993 to 2001, while the sample period in our paper is from 2000 to 2010. Second, Fan, Wong, and Zhang (2007) study both politically connected CEOs and board chairpersons; while we only focus on politically connected board chairpersons in this paper.

3. The CSRC makes decisions on IPOs, SEOs and delisting based on accounting measures. Studies suggest that earnings management activities often take place before IPOs, SEOs and the delisting process (Yang, Chi, and Young, 2012; Liu and Lu, 2007).

4. The firm characteristics and listing requirements of these two boards are very similar. In general, the only difference is that firms listed in the main board are bigger in size.

Additional information

Notes on contributors

Jing Chi

Jing Chi is currently an associate professor in School of Economics and Finance, Massey University, New Zealand. She became a CFA charterholder in 2005. Her academic publications and research interests are in the areas of Chinese IPOs, corporate finance and corporate governance.

Jing Liao

Jing Liao is currently a lecturer in School of Economics and Finance, Massey University, New Zealand.Her research interests include privatization, corporate governance in emerging markets, political connections and expropriation.

Xiaojun Chen

Xiaojun Chen was a former Masters student in School of Economics and Finance, Massey University, New Zealand.