Stock Index Adjustments and Corporate Earnings Management：Based on a Quasi-natural Experiment

Abstract

As one of the basic institutions of capital market, stock index adjustments have attracted extensive attention from researchers and investors. Existing research on stock index adjustments mainly focuses on the impact on stock prices and stock trading volume, and barely discusses its long-term economic consequences. In addition, there are controversies about the information content of stock index adjustments in existing studies. Therefore, from the perspective of earnings management, this paper explores the long-term impact of stock index adjustments on corporate behaviors. The impact of stock index adjustments on corporate earnings management may have two opposite effects. On the one hand, stock index adjustments have a supervisory effect. After stocks are adjusted into stock index, these stocks will receive analysts’ attention and institutional investors’ shareholding will increase significantly, which may increase the company’s external and internal supervision and reduce the manager’s opportunistic behaviors; and the popularity and reputation of these adjusted stocks will improve and attract attention of the media and potential investors, thereby reducing earnings management behaviors. On the other hand, stock index adjustments have a stress effect. Due to the short adjustment period of stock index, in order to avoid stocks being transferred out of stock index and maintain the company’s reputation, the management is under pressure to ensure the continued selection of the company’s stocks by improving performance, which may adopt short-sighted behaviors for earnings management.Using 23 adjustments of the CSI300 Index from June 2007 to June 2018 and the back-up stocks announced during the same period as the research sample, this paper designs a DID model to examine the impact of stock index adjustments on corporate earnings management. The study finds that stock index adjustments have a significant impact on alleviating real earnings management, while the impact on accrual earning management is not significant, indicating that the supervisory effect of stock index adjustments has played a main effect. After a series of robustness tests, the results are still significant. Further research shows that stock index adjustments reduce real earnings management mainly through abnormal cash flows; in terms of duration, the impact of stock index adjustments on reducing real earnings management will still exist three years after being adjusted into index; and under different constraints, the impact of stock index adjustments on real earnings management is more significant when the ratio of independent directors is low and when the company is non-state-owned.The contribution of this paper may have the following three aspects: First, it enriches the research on the economic consequences of stock index adjustments, and provides supporting evidence for the information content of stock index adjustments. Second, from the basic institutions of capital market, it expands the research on the determinants affecting corporate earnings management. Third, in the research design, with the help of Chinese unique back-up stock institutions, it uses a DID model and controls the annual fixed effect, industry fixed effect, and company fixed effect to alleviate the endogenous problems existing in previous studies. For investors, this paper is helpful for them to further understand the impact of stock index adjustments, improve their understanding of adjusted stocks, and then optimize the efficiency of asset allocation.