Title: Earnings Management to Tunnel: Evidence from China's Listed Companies
Reference Number: 1097
Publication Date: February 2004
JEL Classifcation: G32, G34, M41, M43

Qiao Liu
The University of Hong Kong

Zhou Lu
The University of Hong Kong


This paper conducts a two-stage analysis to demonstrate that earnings management in China's listed companies is mainly induced by controlling owners' tunneling activity. In the first stage, we relate our analyses to prior research on Chinese listed companies which has documented their strong incentives to manage earnings in order to meet certain return on equity (ROE) thresholds. We identify tunneling evidence in two scenarios where such practice has been most conspicuous. In the second stage, we examine systematic differences in earnings management across the universe of China's listed companies during 1999-2001. We provide cross-sectional and timeseries evidence showing that firms with higher corporate governance levels tend to have less earnings management. Our empirical findings although not being able to completely exclude other theories, strongly suggest that agency conflicts between controlling shareholders and outside investors are the main stimuli of earnings management in China's listed companies.


Key words: earnings management, tunneling, corporate governance, and Chinese listed companies

Last modified: 06/18/2004