Mandatory Adoption of International Financial Reporting Standards and Earnings Management: Evidence from China

Abstract

We investigate the implications of mandatory IFRS adoption by Chinese listed firms for earnings management behavior, and whether those implications vary by type of controlling shareholder. We find that the increased financial reporting flexibility under IFRS provides more earnings management opportunities for firms operating in emerging markets, where investor protection and corporate governance are deficient. We find that whereas the magnitude of discretionary accruals for firms owned by local governments (local SOEs) and private investors (NSOEs) increased after IFRS adoption, it remained unchanged for firms owned by the central government (central SOEs). More interestingly firms changed the forms of earnings management to take advantage of the flexibility under IFRS; they switched from internally making accounting errors to changing accounting policies and estimates. Evidence on the value relevance of earnings following adoption of IFRS indicates that the informativeness of earnings decreased for local SOEs and for NSOEs, but remained unchanged for central SOEs.

Keywords: International Financial Reporting Standards, Earnings Management, China