Institutional Incentives and Earnings Quality: The Influence of Government Ownership in China

Abstract

We examine the effect of government ownership and its associated institutional incentives on firms’ earnings quality using a sample of Chinese firms during the transitional economy between 1998 and 2005 when state-owned and non-state-owned firms were traded in the stock exchanges. We find that, in China, state-owned firms exhibit a lower earnings quality property than non-state-owned firms. Particularly, state-owned firms have more earnings smoothing, more frequently managed earnings toward target, less frequent timely recognition of losses, and less value relevance, relative to non-state-owned firms. We also find that state-owned firms have significantly higher discretionary current accruals than non-state-owned firms. We conclude that the Chinese government, through its controlling ownership of state-owned firms, creates incentives and regulatory backing for self-serving purposes that negatively influence these listed firms’ financial reporting.