Manipulation of Accruals and Real Activities for Earnings Management: A Study of the Chinese Stock Market

Sammanfattning: Since 2014, international investors gained unrestricted access to the Shanghai and Shenzhen Stock Exchanges for the first time since they were established. However, whether investors can seize the investment opportunities or not highly depends on the reliability of financial statements. Unfortunately, Chinese listed firms do not have a high reputation of transparency and honesty with their earnings. Even the Chinese government admits that accounting quality in mandatory disclosures is not satisfactory. At the same time, research about the reliability of reported earnings and the extent of earnings management does not reach consistent conclusion. This paper examines the extent of earnings management in a wide sample of listed Chinese companies. Both manipulation of accruals and of real activities are considered using models developed based on Jones (1991) and Roychowdhury (2006). There is evidence of significant earnings management, which is equivalent in size to 1.8-7.9 percent of total assets. The largest and most frequent manipulations occur in production costs. Furthermore, the paper discusses how alternative model specifications and estimation approaches affect the resulting estimated size of earnings management.