Ownership Structure, Eearnings Management And Stock Price Behavior

The effect of corporate governance on equity price and the distribution of returns is animportant issue in corporate finance. Based on the continuously changing institutionalbackground of China and the unique ownership structure of Chinese listed firms, this thesisempirically examine the role of firm-level investor protection mechanism and the earningsmanagement on the inflow of firm-specific information to capital market, and consequently thedistribution of stock returns. Moreover, I further investigate the economic consequences of highmoments of the distribution of returns; specifically, I test the impact of idiosyncratic volatilityand crash risk on the cost of equity capital.First, using a large sample of Chinese listed firms for the period1998-2010, I examinewhether and how ownership structure, specifically government ownership, thelargest-shareholder ownership concentration and foreign ownership, and earnings managementaffect the amount of firm-specific information incorporated into share prices, as measured bystock price synchronicity, and firm-specific stock price crash risk. Using the prior three years'moving sum of the absolute value of discretionary accruals as a measure of earningsmanagement and combined with exogenous shocks such as new accounting standards reform andsplit share structure reform in China. The main findings are as follows:1) The magnitude of earnings management is strongly positive associated bothsynchronicity and crash risk. These results are consistent with the information managementinterpretation for R2and crash risk (Jin and Myers,2006; Hutton et al.,2009): firms manageearnings to shelter bad information up to a point, but, once some tipping point is crossed, theinformation comes out in one fell swoop, which results in a price crash. However, these relationsseem to have dissipated since the New Accounting Standards Reform in2007, suggesting thatearnings management has decreased or that managers can hide less information in the newaccounting standards environment.2) There is only a positive and significant association between earnings management andsynchronicity in the subsample of government controlled firms, and I find no evidence thatearnings management positively affect synchronicity for non-government controlled firms.Moreover, compared to non-government controlled firms, the synchronicity and crash risk aresignificantly higher for government controlled firms, even after controlling for the magnitude ofearnings management. These findings strongly support the hypothesis that compared tonon-government controlled firms, the absence of practical owners and the significant divergenceof voting rights and cash flow rights make the managers for government controlled firms moreincentive and able to manage and hide more firm-specific (bad) information flow (bymanipulating earnings) to the market, to facilitate the extracting of private control benefits,which will result in lower stock price informativeness and higher crash risk.3) I find a concave relation between synchronicity and ownership concentration: asconcentration increases, synchronicity increase at a decreasing rate up to its maximum threshold, after which it begins to decreases. And I find only weak evidence that crash risk is a convexfunction of ownership concentration.4) Both synchronicity and crash risk are significantly lower for firms issuing A+B or A+Hshares than for firms issuing just A shares, suggesting that foreign ownership enhances firminformation environment in emerging markets, thus facilitate the capitalization of firm-specificinformation into stock price and reduce crash risk.5) Both synchronicity and crash risk are decreased after split share reform for all firms;however, the effect is larger for non-government controlled firm. These results consistent withthe hypothesis that the relax of share transferability rights after the reform makes the incentivesof shareholders with large equity stakes in the company more aligned with the incentives ofminority shareholder, and more prone to disclose high quality information to reduce agency cost.Second, I investigate whether and how split share reform and the asymmetric disclosureincentive to withhold bad news for managers affect the cost of corporate equity. Based on thesample of Chinese listed firms from2002to2010, using a new approach recently developed byHou et al.(2012) to estimate the cost of capital for Chinese listed firms and after controlling forfactors such as firm size, market beta, book-to-market and leverage, I find that:1) The prohibition on share transferability significantly affects the implied cost of Chineselisted firms. The cost of capital sharply decreased after the removal of share transferabilityprohibition. Idiosyncratic risk is positive associated with the implied cost of capital; however,this relation is weakened after the split share reform. These results strongly support andcomplement the insights of Li et al.(2011), suggesting that the reform enhance thediversification for the previous non-tradable share holders and thus weaken the pricing effect ofidiosyncratic risk. The findings highlight the risk-sharing gains in the split share reform.2)Firm-specific crash risk is positive associated with implied cost of capital, even aftercontrolling for the effect of split share reform and idiosyncratic volatility, suggesting that theasymmetric disclosure for bad news and good news if priced by the market. Investors requirehigher expected return for firms with more severe bad news hoarding.My main results are robust to different measures of key variables, econometricspecifications and sample selection criteria. My study contributes to the theoretical insights andempirical finds of Jin and Myers (2006), indicating that firm-level corporate governance isimportant in forming the firm information environment in emerging markets where country-levelinvestor protection is relatively poor. My findings highlight the importance transferability rightsin property rights arrangement.