Chinese Tango: Government Assisted Earnings Management

Abstract

In a Socialist market economy like China, the relations between various layers of government and state-owned enterprises are tangled. When the Socialist system embraces the market economy, it creates many facets of interest conflict and goal incongruence. This paper describes the collusion between local government and state-owned enterprises in conducting earnings management to circumvent central government regulation, a phenomenon known as Chinese Tango. Our study shows that the local government has actively participated in earnings management of the listed firms located in her jurisdictions by providing them fiscal transfers. The primary purpose of this government-assisted earnings management is to assist the firms to manage accounting earnings so as to meet the regulation stipulated by the central government.

Keywords: local taxation, fiscal transfers, rights offering, earnings management, returns on equity (ROE)

JEL Classification: M41, M43, G38, H25