Foreign ownership and earnings management

We examine whether foreign investors mitigate earnings management activities using manually collected data on foreign ownership in China from 2003 to 2018. We provide evidence of a negative and robust relation between foreign ownership and earnings management. In particular, we find that foreign investors display great market discipline and provide monitoring benefits through the enhancement of corporate transparency. Moreover, we find that foreign investor effects differ across SOE and non-SOE firms that foreign investors are less effective monitors in curbing the prevalence of earnings management at SOEs. In addition, the effective oversight of foreign investors over earnings management depends critically on the investment environment at their home countries and their governance involvement. Specifically, we conclude that foreign investors from countries with low disclosure quality, high information asymmetry or poor monitoring intensity, from civil-law countries, or non-IFRS countries to a smaller extent, disseminate good governance practices through their investments and constrain earnings management. We also find that large cultural distance or small institutional distance reduces the disciplinary effect of foreign ownership on earnings management. Overall, our findings suggest that foreign investors play an important role in deterring opportunistic behaviour by managers in emerging markets.