Empirical Research On Intended Discretion Of Financial Reports In China Listed Companies

Accounting information of high quality is the foundation of capital markets and affects market efficiency and resources allocation. Participants in the markets, e.g. investors, debt holders, management and regulatory authority are all very concerned on the quality of accounting information. However, except for inside management, all the outside investors, debt holders and regulatory authority can only get access to the accounting information by financial reports. The production of financial reports includes the subjective judgments from the management inevitably. Using legal (accounting choice) or illegal (frictional transactions) ways, management has impacts on the final outcome of financial reports so as to the quality of accounting information. Accounting information of low quality cannot reflect the financial status and operating results fairly and will shake the foundation of capital market which harms the investors, hinders regulatory authority and increases the risks for auditors. This paper focuses on the financial reports of listed companies and discusses the intended discretion by management from the perspective of production of financial reports.For investors, detecting intended discretions in financial reports improves the investment efficiency with more accurate information on operating results. For regulatory authority, detecting intended discretions and discriminate the type of discretions are the basis for regulation rules which protect investors and improve the market efficiency. As for independent auditors, if they can predict the discretions from management and tell the type of discretions, the audit efficiency will be increased and audit risks will be decreased.As an important part of capital market research, there has already been extensive research on the distorted financial reports. However there are still obvious defects in extant researches. From the perspective of fundamental theory, there is no solid theoretical framework; most researches just focus on certain opportunistic factors, which overlook the deeper source of intended discretion. From the opportunistic perspective, the researches are confined to narrow scope and hard to take intended discretion as a whole or build a systematic view. Extant research mixed different types of intended discretion and does not take the consequences into consideration. In particularly, the opportunistic perspective is always related to subjective judgments with negative attitudes, which cause the results lacking of objectivity.The defects in fundamental theory cause three serious shortcomings. Firstly, extant papers mix earnings managements and frauds rather than put them into different categories. Earnings managements and frauds are both intended discretions, but they differ in methods, tactics, effects and economic consequences. So if they are treated equally, the results are limited. Secondly, there is little research on the economic consequences of intended discretion. Due to the "motive-consequence" module, after proof of factors related intended discretion, most researches infer negative consequence of intended discretion without providing any evidences. Finally, most domestic researches cite foreign results without consideration of the characters of China capital markets. China capital market is both "emerging" and "transitional" which causes the less powerful explanation by foreign researches.In order to avoid precedential limitations, this paper takes revelation principle as theoretical framework and reviews the extant researches according to "3C". After the summary of extant researches, this paper takes the perspective of communication from "3C" with respect to the low transparency in China capital market. Based on information asymmetry, environmental factors are used to detect intended discretion. Different types of intended discretion are discriminated by attitudes towards information asymmetry. After these, the consequences of different types of intended discretion are tested separately to discuss the effects of transparency and attitudes towards information asymmetry.Specifically, this paper targets at four goals:Goal 1, defining intended discretion and exploring the relation between earnings management and fraud to discriminate different types of intended discretion. Goal 2, seeking the roots of intended discretion from the perspective of revelation principles and setting up framework based on the low transparency of China capital market; Goal 3, detecting intended discretions by environmental factors and discriminating the type of intended discretions with attitudes towards communications; Goal 3 testing the economics consequence and seeking the influential factors related to disclosure transparency.According to the goals, this paper can be divided into 4 levels:Level 1 is the definition of basic concepts. Based on the review of extant researches, level 1 presents the defects and shortcomings in current research, defines intended discretion and tests the relations between different types of intended discretions. Level 2 builds up theoretical analysis. Revelation principles are imported to review extant literature. After discussion the limitation of extant research, the detection and consequence of intended discretion are analyzed from information asymmetry. Level 3 is the empirical test. Information asymmetry is used to detect intended discretion and economic consequence are tested by the market reaction and affecting factors. Level 4 concludes.This paper results in three dimensions. Firstly, frauds are not evolved from earnings managements but they are two different types of intended discretion. Secondly, information asymmetry can be used to detect intended discretion and different types of intended discretion diverge in the attitudes to communication. Thirdly, earnings management has positive consequences in general, which enhance value relevance of accounting numbers. The transparency of disclosure is vital to the consequences. If the transparency is good, the positive consequences of earnings management enhanced. If the transparency is bad, there would be negative consequences. Frauds take advantage of information asymmetry to mislead investor, which decrease the value relevance of accounting numbers.Based on the above research logic, this dissertation consists of 8 chapters which proceed as follow:The first chapter is the introduction. In this part, some basic issues in the dissertation are mainly discussed, including the research background, the theoretical value and practical application value of this dissertation, the basic ideas and method, and main research contents.Chapter 2 reviews extant literature. The review of extant research on intended discretion provides defects in current conclusions from two perspectives:earnings management and fraud and reaches the emphasis of this paper. According to the foreign research, earnings management and fraud are in two different disciplines and there is no crossover. There is no clear definition of intended discretion. However, there are no full researches on economic consequence in neither China research nor foreign research.Chapter 3 defines concept of intended discretion. Different types of intended discretions are compared to tell the relation between earnings management and frauds. Current researches take earnings management and fraud into the same category. And frauds are thought to be evolved from earnings management. However, there is no significant earnings management in the year prior to the fraud or in the year of fraud.Chapter 4 provides theoretical building blocks. Revelation principle is imported as framework to evaluate extant research. Based on revelation principle, if communication, contracting and commitment do not hold simultaneously, there will be intended discretion. Current researches usually take the perspective of contracting and do not take communication into consideration. As emerging capital market in transitional economy, China capital market suffers a lot from information asymmetry.. So the communication perspective explains the intended discretion in China better.Chapter 5 analyzes intended discretion. From the perspective of communication, intended discretion is analyzed with respect to information asymmetry. According to information asymmetry, factors related to communication are explored to detect intended discretion. And the types of intended discretion can be discriminated by attitude towards communication. Under information asymmetry, frauds and earnings management lead to different consequences and transparency of disclosure is vital factor.Chapter 6 studies the detection of intended discretion and discriminates of types of intended discretion. Based on fraud earnings management and normal companies, information asymmetry is tested to detect intended discretion. And attitudes towards communication are used to discriminate types of intended discretion. Empirical results show that environment factors related to information asymmetry could, be used as tools to detect intended discretion. When there are frauds, management is inclined to increase information asymmetry to mislead investors. Management who convey private information takes measures to decrease information asymmetry. Attitudes toward communication can be used to discriminate the types of intended discretion.Chapter 7 tests the economic consequences of intended discretion by long-term market reactions. Market can identify earnings management and react properly in general. The measures to improve transparency enhance the convey of private information by earnings management. So the regulatory authority should emphasize transparency of disclosure which improves the positive effects of earnings management by market force. In contrast, market could not detect fraud by itself. So that is the major task for regulatory authority.Chapter 8 concludes. This part presents the major conclusions and the limitations as well as directs future research.This paper makes three contributions to extant literature. Firstly, different types of intended discretion are well defined. Without local empirical results, current domestic researches speculate frauds go further than earnings management by borrowing the international results. Frauds and earnings management are compared carefully to find out that they are two different types of intended discretion. Secondly, Framework is built on revelation principle to review extant research. Communication is not considered in current research. In order to reach more objective results, this paper takes the view of communication to avoid bias from opportunistic perspective. Thirdly, economic consequences of intended discretion are tested to avoid subjective bias, which also provide theoretical evidence for regulatory authority.