The Spillover Effect of Bright-Line Tests: Evidence from China
19 Pages Posted: 1 Nov 2015
Date Written: October 30, 2015
China’s Shenzhen Stock Exchange used to require firms listed on its ChiNext Board and Main Board to forecast earnings when they expected a loss, a profit after a prior loss, or an earnings increase or decrease by at least 50%. Starting from fiscal year 2011, all firms on the ChiNext Board are required to provide earnings forecasts regardless of expected earnings, and hence are no longer subject to these bright-line tests. Firms on the Main Board, however, continue to follow the original mandate with bright-line tests. We find that after the removal of the bright-line tests, ChiNext firms’ earnings change distribution still shows a discontinuity at the -50% threshold, with unusually low (high) frequencies of earnings changes just below (above) -50%, consistent with ChiNext firms manipulating earning to avoid the -50% earnings change threshold. Moreover, the magnitude of the discontinuity is similar to that of Main firms. This finding suggests that bright-line tests have spillover effect on firms not currently subject to these tests.
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