Regulations, Incentives And Earnings Conservatism

Conservatism, which has been regarded as "the most ancient and the most influential accounting principle (Sterling,1967)", plays a fundamental role in the accounting recognition and measurement. According to the present literatures, we are able to make a summation for it:on the aspect of special phenomena resulted from conservatism:①about the magnitude of account recorded, it demands the methods that least likely to overestimate net income or net assets when facing uncertainty;②at the aspect of timeliness, it demands a more timely recognition of losses than gains—the essence of earnings conservatism:the asymmetric recognition of losses vs gains (Basu,1997).Conservatism has a profound influence to the enterprise and the market. Based on the numerous researches, earnings conservatism can not only improve the quality of accounting information, but also suppress opportunism behavior of the managers. Thus, earnings conservatism is an proxy of high-quality financial reporting, and also an effective corporate governance mechanism. Therefore, earnings conservatism has been received growing attention throughout global accounting academic and practical circles, and has been applied in accounting standards extensively.How can the earnings conservatism be made? Western academic circles have the explanations from contracting,litigation,taxation and regulation. However, given the effects from special shares structures, poor corporate governance, strong influence of government on the local banks, poor regulation and ineffective legal system etc, those four explanations have significantly different weight on earnings conservatism in China from that in developed countries.Based on the Stakeholder Theory, earnings conservatism can be regard as a generalized contract, which can alleviate the conflicts of stakeholders and reduce firms' economic cost. Speaking of Chinese listed firms, various stakeholders have disparate preferences to the earnings conservatism. And, the government supervisors and the insiders of listed firms are the main body of earnings conservatism forming, because of the stronger gambling strength. For one thing, the government supervisors prefer the conservatism and realize it by establishing the accounting regulations. For another, the insiders of listed firms have the incentives to weaken the conservatism, which may shrink their economic and political benefit. Therefore, the existence and the change of earnings conservatism of Chinese listed firms are decided by the gambling of government supervisors and insiders, namely the synthesis influence of accounting regulation restraint and firms'incentives.In order to overcome the limitations of Basu (1997) model which is used extensively in the existing research, this dissertation construct a new model to measure the earnings conservatism, from the perspective of DKW(1998) model(Operation Cycle Effects Model) and based on the relationship of operating accruals and operating cash flows. Also, this dissertation uses the observations from Chinese listed firms (year1999-year2006, A share market, excluding the ones from the finance industry) to empirically test the synthesis influence of accounting regulation restraint and firms'incentives.After testing, the research indicates that:①No trace of conditional conservatism in Chinese listed firm in year1999-year2006.②As the effects of accounting reform, the firms have made significant progress in the sense of earnings conservatism. The effects from the reforms of accounting standards are asymmetric—it has significantly improved the timeliness of losses recognition, meanwhile its effects on the deferral of gains recognition are not significant, nearly 0.③The state ownership and control has weakened the earnings conservatism to a certain extent.④The insider control problem have weakened the earnings conservatism significantly, and the state-owned firms have been more serious.⑤The debt has no significant influence to the earnings conservatism.The research also shows that although the reforms of Chinese accounting regulations has put more and more weight on the principle of conservatism, the actual effects are not satisfactory, because the effects are restrained by the benefit drive of listed firms. Speaking of Chinese listed firms, the accounting regulation, which is a compulsory external restraint made by government, is no more than a necessary condition for the improvement of earnings conservatism; its final effects also depend on the incentives of listed firms. The government should not only improve the quality of accounting regulation, but also improve the quality of the legal and the regulation systems related, such as it also demands to further strengthen the legal liabilities of the external auditors, improve the regulation system for the disclosure mechanism of accounting information and the disclosure mechanism itself, introduce more effective regulation system and more severe punishment for the firms and their management manipulating earnings.This paper attempts to realize the innovation in the following aspects:First, this paper has systematically studied the formation mechanism of conservatism of Chinese listed firms, and enriched the theory of conservatism. At present, most domestic researches focus on the empirical testing of the western explanation, lacking in analyzing the formation mechanism of conservatism. Based on the Contact Theory, Stakeholder Theory and Chinese special system, this paper has analyzed the stakeholders who affect conservatism, improved the generalized contracting explanation, and analyzed the formation mechanism of conservatism of Chinese listed firms.Second, this paper has measured the conservatism from a new perspective, developing the measurement of conservatism. Considering the fact that there are serious limitations of Basu (1997) model, the paper has constructed a new econometric model for measuring conservatism, which is based on the relationship of operating accruals and operating cash flows.Third, this paper has empirically tested the synthesis influence of accounting regulation restraint and firms'incentives on conservatism. Based on the theoretical analysis and the new econometric model, the paper has some discoveries, which are inconsistent with the existing related researches.This paper is arranged in seven chapters. The content of each chapter is as following:Chapter 1:Introduction. This chapter introduces the research context, research topics, paper's structure and innovation.Chapter 2:General Theory of Conservatism. Firstly, this chapter discusses the concept of conservatism. Secondly, reviewing the existence proof of conservatism, from cross-section existence, international comparison and developing trends. Thirdly, reviewing the influence of conservatism on investment, financing and the quality of financial report. Finally, summarizing the conservatism measurements, which was quoted in the relevant literature. Chapter 3:Analysis of Chinese Special System Background. First, introducing China's accounting system reform, and commenting on it from the perspectives of governance, capital market and conservatism. Second, introducing and commenting on the states enterprises reform, especially on split-share problem. Third, discussing the equity financing preference of listed firms and securities regulation.Chapter 4:Formation of Conservatism:Theoretical Analysis and Research Hypothesis. First, introducing the four explanations of western academic circle. Second, analyzing the suitability of the western explanation in China. Third, analyzing the formation mechanism of conservatism.of Chinese listed firms, using the Stakeholder Theory. Fourth, improving generalized contracting explanation and the research hypothesis to be empirically tested.Chapter 5:Design of the Research. First, this chapter elaborates the econometric model used for empirically test, which is based on the relationship of operating accruals and operating cash flows. Second, giving the detailed explanation about the sampling method, data source and variables definition..Chapter 6:Empirical Test Results and Analysis. This chapter shows and analyze the empirical test results, including:test of the relationship of the cash flow change and accruals, test of the relationship of the cash flow change and abnormal accruals, test of the relationship of the cash flow change and positive/negative abnormal accruals, test of the influence of accounting regulation on conservatism, test of the influence of accounting regulation and firms' incentives on conservatism.Chapter 7:Conclusion, Policy Enlightenment and Research Limitation. First, this chapter has induced the main conclusion of the paper. Then, elaborating some policy enlightenment from the research. Finally, some limitation in this paper and future research issues are discussed.