Parent firm dividend payouts and subsidiary earnings management: Evidence from mandatory dividend policy

Abstract

Despite the increasing prevalence of business group structures, earnings management within these groups has not been thoroughly explored, particularly concerning the impact of internal decision-making processes. This study fills this gap by investigating the effect of parent firm dividends on the earnings management of subsidiaries within a group. Using the establishment of China’s State-owned Capital Operating Budget System as an exogenous shock, we find that parent firm dividends significantly reduce the earnings management of subsidiaries. A mechanism analysis reveals that the improved earnings quality is primarily driven by the increased financing demand due to net capital outflow at subsidiaries rather than the agency problem mechanism based on dividend agency cost theory. Parent firm dividends primarily reduce downward earnings management and have a stronger influence on subsidiaries with shorter control chains. Heterogeneity analysis shows that this mitigating effect is more pronounced in firms with weaker external financial support and higher information asymmetry. Overall, we analyze how dividends paid by state-owned parent firms affect earnings management among their subsidiaries, offering valuable insights to business groups and state-owned entity managers involved in corporate governance.