Controlling Shareholder’s Share Pledging and Accounting Manipulations

62 Pages Posted: 19 Nov 2018 Last revised: 2 Feb 2019

See all articles by Douglas V. DeJong

Douglas V. DeJong

University of Iowa - Tippie College of Business

Ke LIAO

Wuhan University

Deren Xie

Tsinghua University

Date Written: January 31, 2019

Abstract

A controlling shareholder can pledge his\her shares to secure personal loans while retaining control of the firm, but share pledging increases the risk of a margin call and the possibility of losing control of the firm. We investigate how share pledging by controlling shareholders influences the financial reporting of the firm. Focusing on China-listed firms, we find that firms with controlling shareholders pledging their shares are more likely to manipulate accounting numbers of the firm to avoid such margin call risks. Specifically, we find that firms with controlling shareholders pledging their shares have more positive discretionary accruals, more income-increasing real earnings management, and a higher propensity of using non-recurring items to avoid losses. We find that the level of accrual-based earnings management declines while levels of real earnings management and non-recurring items continue as the controlling shareholder repeatedly pledges his\her shares. Such manipulations reverse when controlling shareholders cease their pledge. Firms with controlling shareholders who pledge their shares exhibit more restatements, worse audit opinions, and more sanctions by regulators, which implies financial reporting quality suffers. Collectively, our evidence is consistent with the view that with shares pledged as collateral, the controlling shareholder behaves myopically by exerting influence over the firm’s financial reporting to defend the value of the share price.

Keywords: Share Pledging, Controlling Shareholders, Accounting Manipulations

JEL Classification: G14, G32, M41

Suggested Citation

DeJong, Douglas V. and LIAO, Ke and Xie, Deren, Controlling Shareholder’s Share Pledging and Accounting Manipulations (January 31, 2019). Available at SSRN: https://ssrn.com/abstract=3274388 or http://dx.doi.org/10.2139/ssrn.3274388

Douglas V. DeJong (Contact Author)

University of Iowa - Tippie College of Business ( email )

108 Pappajohn Business Building
Iowa City, IA 52242-1000
United States
319-335-0919 (Phone)

Ke LIAO

Wuhan University ( email )

Wuhan, Hubei Province 430072
China

HOME PAGE: http://ems.whu.edu.cn/en/50/1/11/2018-07-26/369.html

Deren Xie

Tsinghua University ( email )

Beijing, 100084
China

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