THE RELATIONSHIP BETWEEN THE MANDATORY ADOPTION OF INTERNAL CONTROL REGULATION AND EARNINGS MANAGEMENT: EVIDENCE FROM CHINA

Abstract

This thesis focuses on an investigation of the relationship between the mandatory adoption of internal control regulation and earnings management in Chinese listed firms, using data between 2007 and 2016. We used accrual earnings management (AEM_DA) as the main proxy for earnings management. After controlling for firm characteristics, and corporate governance variables, the findings indicate that the mandatory adoption of internal control regulation was significantly and negatively associated with earnings management. To check the robustness of the results, we examine whether the mandatory adoption of internal control regulation had a similar impact on three measures of real earnings management. They are: (i) abnormal cash flow from operations (REM_CFO), (ii) abnormal discretionary expenses (REM_DISX), and (iii) abnormal production costs (REM_PROD). The results show that the impact of mandatory adoption of internal control regulation was generally consistent across all forms of earnings management. However, it had more effect on accrual earnings management than real earnings management. In particular, we found that it had limited effects on constraining real earnings management by manipulating production activities. We also used the propensity score matching (PSM) method to confirm the robustness of our findings. As one of the pioneering studies on the Chinese internal regulatory environment, this thesis contributes to studies on the effectiveness of internal control regulation on the quality of financial information.