Financial Packaging of IPO Firms in China

Abstract

This paper examines the earnings patterns of initial public offering (IPO) firms in China to shed light on the role of earnings management in the "financial packaging" of Chinese state-owned enterprises (SOEs) for public listing. We base our analysis on the case of B-Shares and H-Shares in China, two types of securities that now allow foreign investors to buy shares in SOEs previously wholly owned by the state. These IPOs mark the beginning of the stock market in China and signify an important step of Chinese economic reform. We examine the pre- and post-IPO earnings patterns for the entire sample, and separately for firms in protected vs. unprotected industries and for B-Shares vs. H-Shares. We find a statistically significant post-issue earnings decline for unprotected industry firms. This earnings decline is most significant for unprotected B-Share firms, and marginally significant for protected B-Share and unprotected H-Share firms, but not significant for protected H-Share firms. In addition, we find some evidence that the accounting accruals of sample firms in unprotected industries decline whereas their cash flows from operations increase after the IPO. Taken together, earnings management in the process of financial packaging seems to depend on the firm's relationship with the central government and on where the securities are listed. The evidence also suggests that the SOEs in unprotected industries may manage accounting accruals to boost earnings and/or list those business units with temporarily high profits resulting from high accounting accruals during the process of financial packaging.

JEL Classification: M41, M43, P31