Earnings Management Surrounding Share Pledges by Large Shareholders: Evidence from Chinese Family Firms

• In Event: Family Owned Firms

Abstract

In order to raise capital for business purposes, large shareholders of Chinese family firms often pledge their shares with financial institution as collateral. In this study, we examine whether firms which have their share pledged may have contributed to opportunistic reporting practices, both prior to and after share pledges. Using archival data from Chinese family sample between 2004 and 2011, we found that discretionary accrual, the indicator of earnings management, are significantly correlated with pledge in pre and post pledge period. As the other debt financing, before share pledge loan, family firms have incentive to manipulate earnings to increase borrowing capacity. If share price drops after share pledge, lenders may require supplement of collaterals or early debt repayment. We found that in post pledge period, share price are negatively correlated with discretionary accrual, which may indicate that firms try to uphold the price, in order to avoid violation of debt covenant. And the results are more robust after "split-share reform" in 2006 which changed non-tradable shares to tradable. This study provides empirical evidence that share pledge would trigger earnings management in family firms. The findings from this study contribute to the ongoing research on earnings management by providing a new scenario. This study has useful implications to Chinese investors and regulator concerning earnings quality. It may also be a reminder for financial institutions that considering to provide share pledged loans.

Authors

• Qingmei Xue, Nanjing University

• Zhizhong Huang, Nanjing University