Corporate governance and income smoothing in China

Abstract

Purpose -The purpose of this paper is to examine empirically whether corporate governance mechanisms have an effect on income-smoothing behavior in the People's Republic of China. Design/methodology/approach -The sample comprises 1,358 companies listed in the Shanghai Stock Exchange and the Shenzhen Stock Market during the period 1999 to 2006. By comparing the variability of income to the variability of sales, an income smoother can be identified if income is less variable than sales. Findings -The authors' empirical results show that income smoothing is more severe when the state is the controlling shareholder of the Chinese listed firm. Firms with more independent directors are more likely to engage in income smoothing. The governance mechanisms such as board of directors, supervisory board, audit committee, external auditors, and shareholders' participation are not effective in curtailing income smoothing in China. Practical implications -For Chinese firms and especially government-linked enterprises, the way in which they present themselves may be significant, since the image they present to potential strategic partners may be marred by suspicions of income smoothing. Originality/value -The paper presents the current development of China's corporate governance system and indicates that agency conflicts between controlling shareholders and minority investors account for a significant portion of earnings management in China.

Corporate governance and performance of financial institutions

“…In other words, if a bank has already reported very strong earnings, the managers have the discretion to publicize the M a n u s c r i p t 12 amount for provisions/reserves and can tolerate some asset losses. In line with our expectations, Yang et al (2012) find that better corporate governance is positively related to income smoothing. Furthermore, in a cross-country investigation of income smoothing, Fonseca and Gonzalez (2008) report less income smoothing with stronger regulation, investor protection, disclosure and institutional environment.…”

“…This indicates that better governed financial firms that are more profitable accrue greater provisions for loan and asset losses. In line with Yang et al (2012), our evidence supports the income smoothing hypothesis and is considered "good news." Consistent with Beaver et al (1989), an increase in loan/asset loss provisions carries a positive signal for the future profitability of financial institutions because strong earnings can survive additional reduction of earnings through greater loan/asset loss provisions.…”

“…The second finding is that better corporate governance of financial institutions is positively related to their provisions and reserves for loan/asset losses. The evidence is consistent with Beaver et al (1989), Wahlen (1994), Tucker and Zarowin (2006) and Yang et al (2012) The remainder of this paper is organized as follows. Section II discusses the characteristics and governance of financial institutions and lays out the hypotheses.…”

“…If IndyMac Bank, Washington Mutual, Wachovia, Citibank, AIG and recently J.P. Morgan, to name a few, had superior governance practices in place, they would have strengthened the performance of other interconnected financial institutions and the entire U.S. financial system.Second, the evidence shows that better governance is positively related to provisions and reserves for loan/asset losses for financial institutions. Consistent withWahlen (1994) andYang et al (2012), better governance is positively related to the buildup of provisions and reserves for loan/asset losses, which supports the income smoothing hypothesis for financial institutions.Based on that, profitable financial institutions with better governance structures are more likely to engage in income smoothing through informative management of earnings and greater compliance with regulations and accounting standards. Furthermore, the findings are similar when we exclude the 2008 crisis period.…”

Fraud in Rights and Contracts: A Review of Bankruptcy Case of Livent Inc. Based on Governance, Risk, and Compliance (GRC) Framework

“…Due to the heavy cash invested, fears emerged to the directors from losses or earnings declines, which would affect the companies credit ratings and their cost of capital simply due to an unfavorable signal from the operation (Rusmin, Scully, & Tower, 2013). Both directors of Livent Inc. and other companies directors always have a strong incentive to avoid losses during the period and have a stronger incentive to increase earnings gradually (Yang & Tan, 2012). Therefore, the risk of future cash flow insufficiency should have been managed carefully by directors through the manageable volume of cash investment by investors.…”