Accrual-based and real activity earnings management at the back door

Evidence from Chinese reverse mergers

Tingting Zhu, Meiting Lu, Yaowen Shan*, Yuanlong Zhang

*Corresponding author for this work

Research output: Contribution to journalArticle

20 Citations (Scopus)

Abstract

We examine how Chinese reverse merger (RM) firms trade off and conduct income-increasing earnings management through accrual-based and real activities manipulation strategies. We find that Chinese RM firms engage in both real activities and accrual-based manipulation at higher levels than non-Chinese RM firms, regular US firms and other Chinese US-listed firms. Further analysis suggests that Chinese RM firms use real activities and accrual-based manipulation as substitutes and tend to transition to real activities management in the years after a reverse takeover. Big 4 auditors can effectively constrain both real activities and accrual-based earnings management in Chinese RM firms. We also find that accruals manipulation is more costly relative to real activities management in the short term because it predicts changes in post-acquisition operating performance in Chinese RM firms. Overall, the results provide practical implications to regulators, investors and auditors on the channels through which Chinese RM firms manipulate earnings and the economic consequence of those manipulations.

Original languageEnglish
Pages (from-to)317-339
Number of pages23
JournalPacific-Basin finance journal
Volume35
DOIs
Publication statusPublished - 1 Nov 2015

Keywords

  • Accrual-based manipulation
  • Earnings management
  • Firm performance
  • Real activities manipulation
  • Reverse merger

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