State VS Private Controlling Shareholders and Earnings Management in China

This study investigates the essential ownership difference and distinct effects of this difference on earnings management between state and private controlling shareholders in China. Controlling shareholders in State Controlled Companies (SCCs) own control rights but no real cash flow rights. This control-ownership divergence creates incentive for controlling shareholders to expropriate corporate resources and further manage corporate earnings to disguise this expropriation behavior. In contrast, Controlling shareholders in Privately Controlled Companies (PCCs) generally own symmetric control and ownership, and thus the earnings management is likely not be linked to the benefits expropriation of controlling shareholders. Empirical results show that the earnings management level is positively correlated to the proportion of shares held by the controlling shareholders and negatively correlated to the balance ratio of other major shareholders for SCCs. However, this is not the case for PCCs. The results support the tunneling hypothesis of earnings management. The evidence of this study should also be useful to policymakers in a number of countries as they plan reforms of state ownership.