Foreign Capital and Earnings Management: International Evidence from Equity Market Openings

60 Pages Posted: 30 May 2019

See all articles by Fangfang Hou

Fangfang Hou

Xiamen University

Jeffrey Ng

Hong Kong Polytechnic University - School of Accounting and Finance

Tjomme O. Rusticus

University of Minnesota

Xinpeng Xu

Hong Kong Polytechnic University - School of Accounting and Finance

Date Written: May 7, 2019

Abstract

The opening of equity markets to foreign investors provides financing opportunities and disrupts the stock ownership structure of the firms in these markets. In this paper, we study how this affects firms’ earnings management in the opening’s immediate aftermath. Using a broad set of countries that opened their equity markets, we find a significantly positive effect on firms’ income-increasing earnings management in the year of opening. We show that there are substantial heterogeneous effects across industries and firms. The positive effect is more pronounced in industries that are more dependent on external financing and for firms that are financially constrained, suggesting that firms’ intrinsic need for equity finance contributes to income-increasing earnings management behaviors. In addition, the effect is weaker when the firm is audited by a Big N auditor, consistent with the monitoring effect of relatively more reputable auditors. We find that income-increasing earnings management is less pronounced in countries with better funded securities regulators and that it is more pronounced in countries with greater corruption. Overall, our results suggest that incentives to attract financing when a country opens its equity market to foreign investors affects firms’ reporting bias.

Keywords: equity market opening, earnings management, equity finance dependence

JEL Classification: G15, G18, M41, M43

Suggested Citation

Hou, Fangfang and Ng, Jeffrey and Rusticus, Tjomme O. and Xu, Xinpeng, Foreign Capital and Earnings Management: International Evidence from Equity Market Openings (May 7, 2019). Available at SSRN: https://ssrn.com/abstract=3383843 or http://dx.doi.org/10.2139/ssrn.3383843

Fangfang Hou

Xiamen University ( email )

Xiamen, Fujian 361005
China
05922183916 (Phone)
361005 (Fax)

Jeffrey Ng

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Tjomme O. Rusticus (Contact Author)

University of Minnesota ( email )

Carlson School of Management
321 19th Avenue South, Room 3-122
Minneapolis, MN 55455
United States

Xinpeng Xu

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

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