How do political connections cause SOEs and non‐SOEs to make different M&A decisions/performance? Evidence from China

This study examines the impact that political connections have on Mergers and Acquisitions (M&A) performance and the decisions of Chinese listed firms. We find that political connections destroy (create) value in SOEs (non‐SOEs). Our findings show that connected SOEs are more likely to acquire local targets, especially when the local unemployment rate is high and when the firms are controlled by the local government, and they are less likely to conduct vertical mergers. M&A decisions of connected non‐SOEs are less influenced by the government; instead, political connections in non‐SOEs help bidders to integrate vertically and obtain external financing support.     

Monitoring or colluding: the role of venture capital investors in the IPO process

We argue and provide evidence that instead of playing a monitoring role, venture capital (VC) investors collude with controlling shareholders in the IPO process of Chinese non‐state‐owned enterprises (non‐SOEs). We show that VC‐backed IPOs’ applications are more likely to be approved by regulators, especially in firms with excess control rights, but have worse post‐IPO performance. Through investing in firms with excess control rights, VC investors are able to make higher exit returns. We further document that VC investors’ role in the IPO process is stronger when they have political connections, hold higher ownership, and when they make pre‐IPO investment.     

Disentangling Managers’ and Analysts’ Non‐GAAP Reporting

Researchers frequently proxy for managers’ non‐GAAP disclosures using performance metrics available through analyst forecast data providers (FDPs), such as I/B/E/S. The extent to which FDP‐provided earnings are a valid proxy for managers’ non‐GAAP reporting, however, has been debated extensively. We explore this important question by creating the first large‐sample data set of managers’ non‐GAAP earnings disclosures, which we directly compare to I/B/E/S data. Although we find a substantial overlap between the two data sets, we also find that they differ in systematic ways because I/B/E/S (1) excludes managers’ lower quality non‐GAAP numbers and (2) sometimes provides higher quality non‐GAAP measures that managers do not explicitly disclose. Our results indicate that using I/B/E/S to identify managers’ non‐GAAP disclosures significantly underestimates the aggressiveness of their reporting choices. We encourage researchers interested in managers’ non‐GAAP reporting to use our newly available data set of manager‐disclosed non‐GAAP metrics because it more accurately captures managers’ reporting choices.     

Does Internal Corporate Governance Complement or Substitute for External Auditing? Evidence from China's Anti‐corruption Campaign

Two competing hypotheses have been developed for the relationship between internal corporate governance and external auditing. One proposes a complementary relationship, while the other suggests it is substitutable. This study takes advantage of China's recent anti‐corruption campaign as a quasi‐natural experiment to explore this relationship. Using a difference‐in‐differences approach, we find that, after the campaign, internal corporate governance improved more in SOEs (state‐owned enterprises) than in non‐SOEs. SOEs were less likely to choose Big 10 auditors after the campaign, while audit firms assigned less experienced auditors to their SOE client firms and charged lower audit fees. These effects were more pronounced in SOEs that exhibited greater improvement in corporate governance. Overall, we find the anti‐corruption campaign improved corporate governance in SOEs but, at the same time, reduced external audit quality, which supports the substitution view. We argue that this result might be driven by the fact that SOEs have limited demand for high‐quality accounting information because the Chinese government maintains strong control over the capital markets.     

Short‐selling pressure and last‐resort debt finance: evidence from 144A high‐yield risk‐adjusted debt

This study examines why non‐financial publicly traded firms knowingly issue wealth destroying Rule 144A debt, which is associated with a negative announcement return and a higher yield. We provide a plausible ‘demand‐side’ explanation (i.e. last‐resort debt financing) for the motivation for issuing such debt. We also provide evidence as to what drives this negative reaction. Our findings suggest that the negative market impact is mainly driven by short‐selling pressure from convertible bond arbitrageurs.     

The Informational Role of Short Sellers: The Evidence from Short Sellers’ Reports on US‐Listed Chinese Firms

Using US‐listed Chinese firms as the setting, this paper studies a novel channel through which investors can acquire information about firms’ financial reporting quality, that is, the reports published voluntarily by short sellers. I find that short sellers tend to target firms that have financial reporting red flags and that exhibit ‘good’ operating performance and stock valuations. Targeted firms experience an average three‐day cumulative abnormal return (CAR) of ?6.4%, and ?13.6% for initial coverage of the firm, and the CARs are more negative when the reports allege more severe misconduct of the firms. Non‐targeted firms also experience losses in value following short seller reports, especially when they hire the same non‐Big 4 auditors as targeted firms and when their earnings quality is poor. In comparison, analysts fail to perform proper due diligence and are much less effective than short sellers in exposing misreporting risk in Chinese firms.     

Institutional investors,controlling shareholders and CEO pay‐performance relationship: evidence from China

Using a large sample of China’s listed firms between 2005 and 2015, we find that domestic mutual funds have a positive effect on the CEO pay‐performance relationship, and this effect becomes stronger when their ownership is higher and closer to the controlling shareholder’s ownership. This effect is stronger in non‐state‐owned enterprises (non‐SOEs), firms facing weaker industry competition incentives, and firms located in more developed regions. However, Qualified Foreign Institutional Investors (QFIIs) do not have such an influence. Overall, our study contends that the effectiveness of institutional investors’ monitoring role is subject to their identity, controlling shareholders and institutional environments.     

Helping hands or grabbing hands? An analysis of political connections and firm value

We construct a unique political connection index to capture variations in the strength of firm political relations in China. The index incorporates various channels through which a firm's executives, chairperson, directors, and other senior officers are politically connected with government officials and bureaucrats. Overall, there is a negative relation between our index and firm value for the full sample, but such negative relation mainly exists for state-owned enterprises (SOEs) and it becomes positive for non-SOEs. Furthermore, close examination shows an inverted U-shaped relation between political connections and firm value for the full sample in general and for non-SOEs in particular: Firm value increases initially at a lower level of connections and then begins to decrease at a higher level. The findings are consistent with the different business objectives and motivations of SOEs and non-SOEs in seeking political connections. Finally, our findings are robust after controlling for potential endogeneity and using an alternative headcount index construction method.     

Accounting of the German Statutory Pension Scheme: Balance Sheet,Cross‐Sectional Internal Rate of Return and Implicit Tax Rate

We present a framework for accounting of the German statutory pension scheme and calculate a balance sheet for the period 2005–14. Estimating a funding ratio of about 90 per cent, we present some policy recommendations in order to restore balancing of assets and liabilities. Extending and applying the methodology proposed by Settergren and Mikula (2005), we additionally estimate the aggregate cross‐sectional internal rate of return of the German pension scheme over this period. We are able to show that these internal rates of return are mainly financed by increasing contributions and by increasing unfunded liabilities. Additionally, our analysis reveals that from an expenditure perspective, the major part of the internal rate of return results from changing longevity rather than other changes. We also estimate the implicit tax rates from a cross‐sectional perspective and find that they can mainly be interpreted as an ‘implicit wealth tax’ on pension wealth. Finally, we analyse the impact of demographic change on the balance sheet employing a population projection. While the pure demographic effect leads to a decreasing funding ratio during population ageing, the automatic balancing mechanisms of the German pension scheme lead to a significant overfunding in the long run from the accounting perspective adopted in the Swedish pension system.     

The impacts of parent’s listing status on subsidiary’s financial constraint and cost of equity capital: the case of equity carve‐outs

We find that listed parents’ carve‐outs have investment‐cash‐flow sensitivities 70 per cent lower than unlisted parents’ carve‐outs, on average. Such a finding is stronger when we consider only equity carve‐outs in technological industries. The finding suggests that listed parents are more capable of alleviating the financial constraint of their carved‐out units than private parents. Our further analysis shows that listed parents’ carve‐outs also have a lower cost of equity than their counterparts, but such difference cannot be explained by corporate transparency, as implied by analyst coverage and analysts’ forecast dispersion. Therefore, we argue that the benefits from affiliation with a listed parent to the carve‐out come mainly from the parent’s financial support rather than an increase in corporate transparency.     

Non‐GAAP Earnings Disclosure in Loss Firms

This study examines the incremental information in loss firms’ non‐GAAP earnings disclosures relative to GAAP earnings. Using a large sample obtained through textual analysis and hand‐collection, we posit and find that loss firms’ non‐GAAP earnings exclusions offset the low informativeness of GAAP losses for forecasting and valuation. Loss firms’ non‐GAAP earnings are highly predictive of future performance and are valued by investors, while the expenses excluded from GAAP earnings are not. Additional tests suggest that loss firms disclosing non‐GAAP profits have significantly better future performance than GAAP‐only loss firms and are not overvalued by investors. Comparing non‐GAAP earnings of profitable firms to those of loss firms, we find that loss firms’ non‐GAAP metrics are significantly more predictive and less strategic. We conclude that non‐GAAP earnings disclosures are particularly informative about loss firms and help investors disaggregate losses into components that have differential implications for forecasting and valuation.     

Investment Dynamics and Earnings‐Return Properties: A Structural Approach

We propose the standard neoclassical model of investment under uncertainty with short‐run adjustment frictions as a benchmark for earnings‐return patterns absent accounting influences. We show that our proposed benchmark generates a wide range of earnings‐return patterns documented in accounting research. Notably, our model generates a concave earnings‐return relation, similar to that of Basu [1997], and predicts that the earnings‐return concavity increases with the volatility of firms’ underlying shock processes and decreases with the level of firms’ investments. We find strong empirical support for these predictions. Overall, our evidence suggests that our proposed benchmark is useful for understanding the joint dynamics of variables of interest to accounting research (e.g., earnings, returns, investment, market‐to‐book) absent accounting influences, a necessary precondition for inferring the effects of accounting from these dynamics.     

Chief Financial Officers’ Short‐ and Long‐term Incentive‐based Compensation and Earnings Management

This study examines the association between chief financial officers’ (CFOs) short‐ and long‐term compensation and discretionary current and non‐current accruals. The CFO's cash bonus is used as a measure of short‐term incentives and shares plus options is used as a measure of long‐term incentives. The results show a significant and positive association between CFOs’ short‐term compensation and the absolute value of discretionary current accruals. The results also show a significant and positive association between CFOs’ long‐term compensation and the absolute value of discretionary non‐current accruals. STUDY provides evidence that the earnings management behaviour of CFOs is associated with type of CFO compensation.     

THE IMPACT OF POLITICAL CONNECTIONS ON FIRMS’ OPERATING PERFORMANCE AND FINANCING DECISIONS

We investigate the impact that the political connections of publicly traded firms have on their performance and financing decisions. Using a long‐term event study covering a sample of 234 politically connected firms headquartered in 12 developed and 11 developing countries from 1989 to 2003, we find that firms increase their performance and indebtedness after the establishment of a political connection. We also find that the political connection is more strongly associated with changes in leverage and operating performance for firms with closer ties to political power. Overall, our study confirms that politically connected firms gain easier access to credit and reap benefits in terms of performance from their ties with politicians.     

Preparers’ control‐risk assessments under alternative audit‐review processes

This study investigates the impact of a decomposed audit‐review process on audit preparers’ control‐risk assessments, taking audit experience into consideration. Using an experiment, it manipulates the audit‐review type (decomposed review versus non‐decomposed review) and preparers’ audit experience level (more experienced versus less experienced). Analysis of data collected from two mid‐tier audit firms supported the author’s predictions. First, working‐paper preparers assessed control risk more accurately in a decomposed than in a non‐decomposed review. Second, less‐experienced auditors benefitted more from a decomposed review than more‐experienced auditors.     

Risk‐Adjusted Long‐Term Contrarian Profits: Evidence from Non‐S&P 500 High‐Volume Stocks

Can trading volume help unravel the long‐term overreaction puzzle? With portfolios of non‐S&P 500 NYSE stocks, we show that (1) both the high‐ and low‐volume (abnormal volume) contrarian portfolios earn a much higher market‐adjusted excess return than the normal‐volume contrarian portfolio, (2) however, when leverage‐induced risk is factored in, excess returns from contrarian portfolios with normal‐ and low‐volume stocks are insignificant, (3) only excess returns from high‐volume contrarian stocks are significant and cannot be explained by the time‐varying risk and return framework, and (4) such high‐volume, risk‐adjusted excess returns arise mainly from winner (glamour) stocks.     

Chairman’s government background,excess employment and government subsidies: Evidence from Chinese local state-owned enterprises

Local state-owned enterprises (SOEs) in China continue to face government interference in their operations. They are influenced both by the government’s “grabbing hand” and by its “helping hand.” Our study examines how SOE chairmen with connections to government influence their firm’s employment policies and the economic consequences of overstaffing. Using a sample of China’s listed local state-owned enterprises, we find that the scale of overstaffing in these SOEs is negatively related to the firms’ political connections to government. However, this relationship turns positive when the firm’s chairman has a government background. Appointing chairmen who have government backgrounds is a mechanism through which the government can intervene in local SOEs and influence firms’ staffing decisions. We also find that in compensation for the expenses of overstaffing, local SOEs receive more government subsidies and bank loans. However, the chairmen themselves do not get increased pay or promotion opportunities for supporting overstaffing. Further analysis indicates that whereas the “grabbing hand” of government does harm to a firm’s economic performance, the “helping hand” provides only weak positive effects, and such government intervention actually reduces the efficiency of social resource allocation.     

Political embeddedness and firms’ choices of earnings management strategies in China

We examine whether and how political embeddedness influences financial reporting quality in China by investigating how government ownership and political connections affect Chinese listed firms’ choices of earnings management strategies. The results show that state-owned enterprises (SOEs), and in particular, central SOEs, are more likely to substitute accrual-based earnings management strategies with costlier but less detectable real earnings management strategies than non-SOEs. The results also indicate that politically connected enterprises (PCEs) are more likely to employ less detectable real earnings management strategies than non-PCEs, so much so that PCEs’ total earnings management level is higher than that of non-PCEs.     

Controlling Shareholders’ Incentive and Corporate Tax Avoidance: A Natural Experiment in China

The split share structure reform removes a significant market friction in China's capital market by allowing previously non‐tradable shares to be freely tradable at market prices. Such a reform reduces the agency conflict between controlling shareholders and minority shareholders as the former now care more about stock prices. We find that state‐owned firms, but not non‐state‐owned firms, significantly increased their tax avoidance activities after the reform. We attribute this differential effect to the dual role of the government as state‐owned firms’ controlling shareholder as well as the tax claimant. Further, this effect is more pronounced for state‐owned firms that are more likely to be influenced by the government prior to the reform. Finally, the reform reinforces a positive association between tax avoidance and firm value. Overall, our study suggests that when controlling shareholders are more concerned about stock prices, state‐owned firms engage more in tax avoidance activities to enhance firm value.     

Political connections,tax benefits and firm performance: Evidence from China

This paper investigates the different effects of political connections on the firm performance of state-owned enterprises (SOEs) and privately owned enterprises. Using data on Chinese listed firms from 1999 to 2007, we find that private firms with politically connected managers outperform those without such managers, whereas local SOEs with connected managers underperform those without such managers. Moreover, we find that private firms with politically connected managers enjoy tax benefits, whereas local SOEs with politically connected managers are prone to more severe over-investment problems. Our study reconciles the mixed findings of previous studies on the effect of political connections on firm performance.