Internal Governance,external Audit Supervision And Earnings Management Of Private Equity Placement Company

The issue of earnings management in the process of stock issuance has always been paid much attention by scholars.Both local and overseas scholars have made in-depth researches on the phenomenon of earnings management in the process of IPO,public offering and rights issue,and generally believe that the policy earnings index is a direct motivation to induce earnings management.Since the split share reform in 2006,private equity placement has become the main way for the refinancing of the listed companies in China.The requirements of private placement are relatively loose compared with IPO,public offering and right issue.And there are no ROE requirements.However,there are cases show that Listed Companies in private placement will also carry out earnings management.This issue has aroused widespread concern in the academic and practical circles.Private placement can be placed to related shareholders such as current shareholders,directors,supervisors,senior managers,core employees and subsidiaries of issuance of new shares and also non related shareholders such as institutional investors and other non related shareholders.Thus most scholars believe that private placement is a tunneling activity which controlled by big shareholders in order to meet the interests of major shareholders and related shareholders.Meanwhile earnings management is one of the most important way to transfer benefits to related shareholders during private placement.Earnings management will be restricted by internal governance and external audit supervision of the company.The financial report is disclosed by internal staff,therefore,earnings management behavior depends on company's internal governance mechanism such as ownership structure,boarders and supervisors;at the same time,auditors hired by company will also try to identify earnings management before the disclosure of financial report.While Most of the existing literature is about the impact of internal governance structure on earnings management barely focus on ownership structure or board characteristics.In this paper,we examine the role of internal governance and external audit supervision in earnings management at the same time.Placement company will act earnings management not just by accruals but also build real earnings management by constructing real transactions.Unlike accruals earnings management,real earnings management is more subtle.Meanwhile,earnings management in real business activities is usually difficult to distinguish from normal business activities.However,most of the existing literature focus on the research of accruals earnings management,and seldom examine the inhibitory effect of internal and external governance mechanisms on the real earnings management of private placement companies.In addition,the auditor selection is affected by internal governance.But high quality audit helps to find the drawbacks of internal control of placement company.The existing literature seldom put internal governance,audit quality and earnings management into the same framework to analysis and discussion their interactions.Based on above,this paper puts internal governance,external audit supervision and earnings management of placement company into the same framework after considering the environment and institutional background of Chinese stock market to study the effect of internal governance and external audit supervision to earnings management of private placement company.First of all,based on literature review,we describe the mechanism effect of internal governance and external audit supervision to earnings management of private placement company.Then we built the prototype theory of internal governance,external audit supervision and earnings management.Secondly,this prototype is embedded in China's capital market environment and institutional background,and then we built test models which based on the specific economic environment and institutional background of China.Finally,we use listed companies as the research samples which carried out private placement during the period from January 1,2006 to December 31,2015.Based on the theory of prototype and model test,we did theoretical deduction and empirical test of internal governance and external audit supervision to earnings management of private placement company.Finally we got the concrete research conclusion.As a whole,there are four main findings of the theoretical analysis and empirical research.Firstly,there exists earnings management before and after issuance of private placement,and the degree of earnings management is related to the buy ratio of investors.Taking the subscription of related shareholders and non related shareholders as the breakthrough point,this paper assumes that the controlling shareholders have self-interest motives under asymmetric information.And we built econometric models to test the existence of earnings management before and after the issuance of private placements.The empirical results show that:(1)Share subscription only by related shareholders,company will carry out negative earnings management while positive earnings management for only non related shareholders before private equity placement.(2)Share subscription only by related shareholders,company will carry out positive earnings management while earnings management is not significant for only non related shareholders before the unlock of private equity placement.(3)After further test,we find that when both related shareholders and non related shareholders attend private placement,the greater relate shareholders' subscription ratio is the greater the degree of earnings management both before private equity placement and unlock of private equity placement.(4)During the robustness test,using the modified Jones model(non performance matching)measure the degree of earnings management,and using propensity score matching(Propensity Score Matching,PSM)model control between the experimental group and the control group to solve the sample selection problem which may lead to endogenous problems.The main conclusions and test results are basically the same.Second,internal governance is an important mechanism to restrain earnings management of private equity placement company.From the perspective of accruals and real earnings management,this paper builds econometric models based on further scientific measurement of internal governance level,and empirically examines the impact of internal governance mechanism on earnings management before and after the issuance of private placements.The empirical results show that:(1)The higher level of internal governance the lower degree of accrual earnings management before the issuance of private equity placement.(2)The higher level of internal governance the lower degree of real earnings management before the unlock of private equity placement.(3)No matter the issuance or unlock before private equity placement,internal governance inhibits more of accrual earnings management compared with real earnings management.(4)During the further test,we divide samples into relate group and non-relate group,the results are the same after repeat the empirical tests.(5)During the robustness test,using the modified Jones model(non performance matching)measure the degree of accrual earnings management,using Roychowdhury(2006)non-adjusted real earnings management model to measure the degree of real earnings management and using propensity score matching(Propensity Score Matching,PSM)model control between the experimental group and the control group to solve the sample selection problem which may lead to endogenous problems.The main conclusions and test results are basically the same.Third,external audit supervision is an important governance mechanism to restrain earnings management of private equity company.From the perspective of accruals and real earnings management,based on further scientific measurement of external audit supervision,this paper built econometric models to empirically test the impact of external audit supervision on earnings management before and after private placements.The empirical results show that:(1)When the private placement company hired high quality auditors,the degree of both accrual earnings management and real earnings management would be lower before the issuance of private equity placement.(2)When the private placement company hired high quality auditors,the degree of both accrual earnings management and real earnings management would be lower before the unlock of private equity placement.(3)No matter the issuance or unlock before private equity placement,high audit quality inhibits more of accrual earnings management compared with real earnings management.(4)During the further test,we divide samples into relate group and non-relate group,the results are the same after repeat the empirical tests.(5)During the robustness test,using the modified Jones model(non performance matching)measure the degree of accrual earnings management,using Roychowdhury(2006)non-adjusted real earnings management model to measure the degree of real earnings management and using propensity score matching(PSM)model control between the experimental group and the control group to solve the sample selection problem which may lead to endogenous problems.The main conclusions and test results are basically the same.Fourth,internal governance and external audit supervision has a complementary effect to earnings management of private equity placement company.In this paper,we put internal governance and external audit supervision into the same framework,and theoretical analysis their effect to earnings management,further built econometric models to test inhibitory effect.The empirical results show that:(1)No matter before issuance or unlock of private equity placement,the degree of earnings management is lower of listed companies with high level internal governance which hired low quality external auditor compared with listed companies with low level internal governance which hired high quality external auditor.(2)Internal governance and external audit supervision has a interaction effects,they inhibit both the accrual earnings management and real earnings management.During this process,internal governance helps to enhance the audit quality and audit quality helps strengthen the internal governance mechanism.They have a complementary relationship to inhibit earnings management.(3)The complementary effect of internal governance and external audit supervision to accrual earnings management compared to the complementary effect of internal governance and external audit supervision to real earnings management.(4)During the further test,we divide samples into relate group and non-relate group,the results are the same after repeat the empirical tests.(5)During the robustness test,using the modified Jones model(non performance matching)measure the degree of accrual earnings management,using Roychowdhury(2006)non-adjusted real earnings management model to measure the degree of real earnings management and using propensity score matching(PSM)model control between the experimental group and the control group to solve the sample selection problem which may lead to endogenous problems.The main conclusions and test results are basically the same.In summary,this paper theoretically analyzed the effect of internal governance and external audit supervision on earnings management of private equity place under considering Chinese specific equity refinancing market environment and institutional background.We also selected the A shares of listed companies which carried private equity placement as the research sample and built econometric models for empirical test.This paper is more detailed presentation of internal governance,external audit supervision and earnings management of private placement company.The results provide suggestions to the relevant functional departments to formulate policies and regulations.It also helps investors to understand placement company and make the right investment decision.There are mainly three contributions: firstly,this paper constructs prototype framework of internal governance,external audit supervision and earnings management of private equity placement company which expand and deepen the theory of earnings management,and also contribute to the study of earnings management from the perspective of internal governance and external audit supervision.It also expand and deepen the corporate governance theory and contract theory which expect to provide new explanation of the phenomenon of earnings management during private equity placement.Second,this paper put internal governance,external audit supervision and earnings management of private placement into the same framework,theoretical analysis and discussion of their interactive relationship.Then we further discusses the effect differences of internal and external governance mechanism between accrual earnings management and real earnings management.It enriches literature of internal and external governance to earnings management.And it also further clarify the dynamic relationship between the company corporate governance and earnings management.Third,the results of this paper provide suggestions for the Ministry of finance to restrain placement company and it provides suggestions to improve Chinese accounting standards.It also provides a new reference for private equity placement company to improve internal governance mechanism and employ intermediary agencies.