Controlling shareholders' propping or tunneling: A choice of earnings management — Evidence from target firms in China

Abstract

This paper documents a unique form of controlling shareholders' propping and tunneling through earnings management prior to China's equity transactions, and we find the significant evidence that the controlling shareholders of targets attempt to employ income-increasing accruals management prior to the mergers that acquirers are not the controlling shareholders of targets so as to increase their revenue from equity transactions and income-decreasing accruals management prior to the mergers that acquirers are actually the controlling shareholders of targets in order to decrease their cost of equity purchases. The results suggest that the accruals management is not general for targets, which is associated with incentives of controlling shareholders related to the accruals. We investigate the shareholder wealth effects of equity transactions and their association with abnormal accruals and find the evidence that the outside investors cannot detect controlling shareholders' propping, but can at least partially see through the tunneling of controlling shareholders. Our results also indicate that the markets are hardly to fully recognize the difference of earnings management between controlling shareholders' propping and tunneling and outside investors cannot effectively predict and penalize the expropriation of minority shareholders only when the expropriation does occur.