Does Governmental Decentralization Accelerate the Accounting Manipulation of State-Owned Enterprises? Evidence from China

Abstract

Pyramidal structures are the common methods to organize enterprises, either private or state-owned around the world. This study considers both political cost and agency cost theory in pyramidal structures constructed by Chinese government mainly for governmental decentralization. Although this pyramids structure, with intermediate layers, support to minimize political costs of governmental intervention, they also detour managers from their top owners and hence aggrandize agency costs. All else equal, according to the agency cost theory, we assume that the changed pyramidal structures enhance motivations of accounting manipulations, because of reducing supervision from the top owners; on the other hand, according to the political cost theory, these pyramidal structures reduce motivations of accounting manipulations for remitting intervention from government. Based on hand-collected data from all Chinese A listed local-state-owned enterprises (SOE hereafter) between 2004 and 2016, we find that the pyramidal structures in China have not achieved the optimal partition of power between the state-owner and the managers where the point at the marginal agency costs are equal to the marginal political costs, encouraging earnings management on SOE after governmental decentralization. We further investigate on whether pyramidal structure is associated with earnings management, and find that managers without holding shares, the lower level of salary and the higher level of interventional districts increase earning management when the level of intermediate layers enhanced.

Keywords: State-owned; Pyramid; earnings management

JEL Classification: D22, D23, G32, L22, L32, P31