Title: Look Who Are Disguising Profits: An Application to Chinese Industrial Firms
Reference Number: 1095
Publication Date: May 2004
JEL Classifcation: G30, G32, H26, M41

Qiao Liu
The University of Hong Kong

Geng Xiao
The University of Hong Kong


This paper develops a fairly general empirical procedure to trace out the extent of profit disguising and examine the motives behind it. Applying the methodology to the National Bureau of Statistics of China (NBS) database which covers more than 20,000 large-and mediumsized industrial firms in China for 1995-2002, we find (i) there is a profit-disguising propensity order by ownership in China (from the weakest to the strongest) — foreign invested firms < Hong Kong or Taiwan firms < state-owned enterprises < mixed firms < collective firms < private firms. Specifically, we find that, based on a conservative estimation, the private firms in China on average disguise 18.5% more profits than the state-owned enterprises and 37.4% more profits than foreign firms; (ii) firms with tighter financing constraints reveal stronger tendency to disguise profit; and (iii) smaller firms tend to disguise more profits. These results suggest that tax evasion, and incentive to overcome financing constraints, together with distorted corporate behavior caused by insecure property rights and weak institutions, account for Chinese firms' profit disguising. We also find that Chinese firms' profit disguising lies principally on revenue rather than cost.


Key words: Profit disguising, tax evasion, ownership, and financing constraints

Last modified: 06/16/2004