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Earnings Management and the Accrual Anomaly: Evidence from China


  • This paper is sponsored by the National Natural Science Foundation of China (Approval No. 70632002 and 70802003), Shanghai Fund of Philosophy and Social Science (2010EJB001), the PhD Programs Foundation of Ministry of Education of China, and the Key Project of Accounting Society of Shanghai. The authors acknowledge the valuable input of Stephen Penman, James Ohlson, Kang Chen, Shenglan Chen, Denton Collins, Deming Dai, Jianqiao Hong, Guohua Jiang, Changjiang Lu, Tong Lu, Danglun Luo, Heng Yue, Xiao-Jun Zhang, Xiaoqiang Zhi, and workshop participants at Peking University, Renmin University, Sun Yat-Sen University, the 2008 AAA conference, the 2007 BFNRX Five School Accounting Conference, the 2007 Two-Strait Accounting and Management Academic Conference, and the 2007 China International Conference in Finance. A previous version of this paper was the winner of the “Best Paper Award” at the 2007 Two-strait Accounting and Management Academic Conference, Taipei, Taiwan.


Using the unique Chinese setting in which the “delisting regulation” is based on accounting numbers, we separate earnings management into (1) earnings management responding to regulation and (2) earnings management prompted by market pressures and further document that earnings management responding to market pressures produces the accrual anomaly (Sloan, 1996) and earnings management responding to regulation does not. Initially unable to detect the accrual anomaly in China's stock market, we were reluctant to conclude that China's market is more efficient than that in the United States. After observing a disproportionate number of “big-bath” loss firm-years in the lowest decile of accruals for our sample, we estimated the apparent earnings distortion induced by the delisting regulation. When we excluded this distortion from our analysis, we documented the presence of the accrual anomaly in China's stock market. We conclude that the delisting regulation creates an artificial distribution of firm earnings in China that affects the market pricing of accruals and masks the accrual anomaly. The results have implications for policy makers and regulators in general, and those in emerging markets in particular.

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