Articlediamond2022

Real earnings management, corporate governance and stock price crash risk: evidence from China

Yuanhui Li · Yezen H. Kannan · Stephen E. Rau

17 citations0/0 files storedChina Accounting and Finance Review

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Auditing, Earnings Management, Governance Corporate Finance and Governance Corporate Governance and Financial Management

Abstract

Purpose The aim of this paper is to provide additional insights on the association between real earnings management (REM) and crash risk, particularly from the perspective of an emerging market economy. It also examines the moderation role that internal and external corporate governance may play in this area. Design/methodology/approach Relying on archival data from the RESSET and CSMAR databases over a timeframe from 2010 to 2018 of China listed company, the authors test the hypotheses by regressing common measures of crash risk on the treatment variable (REM) and crash risk control variables identified in the prior crash risk literature. The authors also introduce monitoring proxies (internal controls as an internal governance and institutional ownership as an external governance) and assess how effective internal and external governance moderate the relation between REM and stock price crash risk. Findings The results suggest firms with higher REM have a significantly greater stock price crash risk, and that this association is mitigated by external monitoring. That is, greater institutional ownership, particularly pressure insensitive owners, mitigates the impact of REM on stock price crash risk. However, internal control does not mitigate the association between REM and stock price crash risk. Originality/value Following the passage of the Sarbanes–Oxley (SOX) Act, prior research has documented an increase in the use of REM and a positive association between REM and cash risk. The authors demonstrate that they persist in one of the largest emerging markets where institutional regulations, market conditions and corporate behaviors are different from those in developed markets. Also, the assessment of the moderation effect of internal and external governance mechanisms could have meaningful implications for investors and regulators in Chinese and other emerging markets.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1986Large Shareholders and Corporate Control 2003Earnings Management through Real Activities Manipulation 1999A Review of the Earnings Management Literature and Its Implications for Standard Setting 1990Additional evidence on equity ownership and corporate value 2002Investor Protection and Corporate Valuation 2008Real and Accrual-Based Earnings Management in the Pre- and Post-Sarbanes-Oxley Periods 2008International Accounting Standards and Accounting Quality

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