Quality of Financial Reporting in China

Xia Wang, Min Wu
2009 Social Science Research Network  
This study uses restatements to reveal the low quality of past accounting information reported within China's capital market. We show that up to a quarter of listed firms in Mainland China explicitly admitted the low quality of financial information by restating their previous financial reports between 1999 and 2005. Many of these firms manage their earnings mainly via below-the-line items to avoid losses and promote survival, rather than to support refinancing goals. Such low quality of
more » ... w quality of financial reporting is more likely among firms that have weaker profitability and a shareholder base that is state-controlled, with diffused ownership and a relatively low proportion of shares held by institutional investors. Furthermore, we find the market to be relatively insensitive to such admission. Investors' reaction captures only the earnings information of the current reported year, rather than also reflecting the concurrently revealed correction of past financial reporting. However, the equity market does not totally ignore the earnings information, as perceived by many. Investors' reliance on earnings is just low relative to the mature U.S. market. These findings demonstrate that accounting credibility in China has low value; providing low-quality financial information bears little cost, since various market mechanisms fail to deter such behavior. Nevertheless, the continuous effort by regulators to enhance listed firms' quality of financial information and disclosure is still fruitful. The frequency of restatements over our sample period is decreasing, which reinforces the current regulatory prospects and strategies for further improving China's capital markets.
doi:10.2139/ssrn.1653278 fatcat:tghaq5db7vd5rfcb7d6srem7eu