Earnings Management via Not-wholly-owned Subsidiaries

55 Pages Posted: 14 Jun 2019 Last revised: 4 Oct 2022

See all articles by Mei Luo

Mei Luo

Tsinghua University - School of Economics & Management

Frank Zhang

Yale School of Management

Xinyi Zhang

Sun Yat-sen University (SYSU) - Business School

Date Written: October 4, 2022


We investigate a new mechanism of earnings management: Income shifting from not-wholly-owned subsidiaries to help the parent company avoid losses at the expense of subsidiaries. Consolidated net income attributable to the parent company (i.e., net income) increases through this mechanism, as the parent company enjoys the full amount of the shifted earnings rather than sharing them with minority investors. We design an empirical model to directly estimate the amount of income shifted from subsidiaries to parent firms. Employing this measure, we find that firms opportunistically decrease earnings of their not-wholly-owned subsidiaries to manage net income upward to avoid losses. The results are stronger for firms with high non-controlling ownership, firms with large-size subsidiaries, firms with strong influence over not-wholly-owned subsidiaries, and firms with a high level of related-party transactions. Our results are robust to alternative research designs, including controls for within-firm variations, alternative earnings thresholds, propensity score matching, and entropy balancing techniques. Our mechanism of earnings management complements traditional accrual or real earnings management and is generalizable to other earnings management scenarios, such as share pledging.

Keywords: earnings management, income shifting, tunneling, subsidiary, loss

JEL Classification: M40; M41; G12; G1

Suggested Citation

Luo, Mei and Zhang, Frank and Zhang, Xinyi, Earnings Management via Not-wholly-owned Subsidiaries (October 4, 2022). Available at SSRN: https://ssrn.com/abstract=3396796 or http://dx.doi.org/10.2139/ssrn.3396796

Mei Luo

Tsinghua University - School of Economics & Management ( email )

Weilun Building 201B
School of Economics and Management
Beijing, Beijing 100084
8610-62773185 (Phone)

Frank Zhang (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Xinyi Zhang

Sun Yat-sen University (SYSU) - Business School ( email )

135 Xingang West Road
Sun Yat-Sen University
Guangzhou, Guangdong 510275

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