Special treatment regulation in China: potential unintended consequences

Abstract

PurposeThe purpose of this paper is to trace the behaviour of Chinese companies receiving a special treatment (ST) designation in order to determine the extent to which the application of this regulation may have led companies to engage in activities conducive to the removal of the ST designation. In particular, the paper examines evidence of opinion shopping or earnings manipulation by these companies.Design/methodology/approachEmpirical analysis of annual report databases for Chinese‐listed companies, including statistical significance testing relating to ST companies.FindingsMost ST companies have removed the ST status by the third year after the initial ST designation. Compared to non‐ST companies, ST companies losing the ST status are more likely to engage in practices indicating earnings manipulation. Also, compared to non‐ST companies, ST companies are more likely to change auditors after an initial or second year of ST designation. However, while this behaviour suggests opinion shopping, auditor switching for the ST companies is not associated with losses becoming profits nor with improved audit opinions.Research limitations/implicationsThe results reported in this paper must be considered in light of the limitations inherent in empirical analyses. That is, the relationships identified in this paper are indicative of potential earnings management or audit opinion shopping; however, the study cannot provide the actual reasons for these empirical results.Practical implicationsThe results suggest the ST regulation did not lead to unintended consequences in terms of auditor switching by ST companies to improve either their reported earnings or their audit opinion.Originality/valueThe ST status is unique to China and this paper is the first to report on potential reporting and audit quality implications of this regulation.