The Effect of Regulatory Benchmarks on Firm Reporting Behavior

• In Event: Disclosure Compliance and Quality

Abstract

In this study, we investigate the effect of regulatory benchmarks (i.e., “bright-line” regulations) on firms’ financial reporting behavior. In China, firms are required to disclose within 30 days after the fiscal year end expected declines in net income of 50% or greater. We first document that firms just beating the regulatory benchmark have higher abnormal accruals and excess non-operating income. These results are consistent with earnings management to avoid changes in earnings falling below the −50% threshold. The ability of firms to avoid missing the regulatory benchmark, however, is reduced in the presence of stronger monitoring (Big 8 auditors, analyst following, exchange regulators, and IFRS). We also find that many firms do not seem to comply with the disclosure regulation. That is, many firms eventually report earnings declines of 50% or greater but did not disclose this news within 30 days after the fiscal year end. Non-compliance is less likely to occur in the presence of Big 8 auditors, analyst following, and IFRS. Our study sheds light on firms’ opportunistic reporting behavior induced by a regulatory benchmark and on the monitoring mechanisms that mitigate such behavior.

Authors

• Yun Fan, University of Houston

• Wayne B. Thomas, The University of Oklahoma

• Chong Wang, University of Kentucky