Corporate Governance And Earning Quality

Corporate governance, a systematic arrangement of various contracts in a firm, is a direct reflection of financial management environment. Corporate governance is closely related with financial management. Especially since Jensen and Meckling(1976) began the research on agent theory, corporate governance has become the focus of corporate finance. Corporate governance is concrete arrangement of the ownership and ownership is an abstract concept of corporate governance. Corporate governance of listed companies in our country is developing and evolving with the reform of state-owned enterprises and the improvement of the external security market. So it has a significant path-reliant characteristic though it has absorbed the advanced governance factors of the developed countries. Research of corporate governance based on ownership and agent theory accords with the building-up of modern enterprise system and satisfies the demand of the reform of state-owned enterprises.Research in the past is mainly about the agent problem between the manager and the owner, but dispersive ownership only exists in several developed country such as the US, the UK. Most counties have relatively dispersive ownership and relatively concentrative control. (La porta1998; Claessens2000; Faccio and Lang 2002), Controlling shareholders, who play a key role in operation management, exist in many companies. Listed companies in China are transferred from state-owned enterprises on which the old system shed shadow. It results in faulty internal governance, especially the ownership. Controlling shareholder and insider control are the popular problem in listed companies.Controlling shareholders make profit by occupying capital of listed companies, guarantee provided by listed companies, dividend and related parties transactions. The purpose of the listed companies is not only the maximum profit of itself but that of the whole group. The behavior of the controlling shareholders certainly will influence the earning quality. Research in this field is meaningful to standardize corporate governance and enhance quality of listed companies and could propose policy suggestions to the authority.Scholars have different definition towards controlling shareholders, HuachengWang, YanTong (2006) substitutes the largest shareholder for controlling shareholder, SongZhu (2006) focuced on the final controller. So in China, whether the controlling shareholder are defined as the largest shareholder or the final controller? In the past, coefficient of market reaction signifies the influence of controlling shareholders on earning quality. But hypothesis of CAPM are not satisfied for the weak efficiency of capital market in China. This paper defines the controlling shareholder under the Chinese environment and then use accounting adjustment method and time series method.This paper explains the systematic background of corporate governance and reviews literatures on corporate governance and earning quality. Listed companies from 2004 to 2005 are chose as samples, finance and real estate industry exclude. Controlling power is divided into four zones. The extent and character of the controlling shareholdersare considered. The study shows: Firstly, in the four zones, earning quality is positively related with circulating shares.Secondly, the proportion of controlling rights have significantly negative relation with earning quality, which is the same with research by Fan et al.(2005) and HuachengWang, YanTong( 2006) but different from SongZhu (2006) .For listed companies in China, as proportion of controlling rights increase, the agent cost of small shareholders increase will be larger than the decrease of agent cost of managers.Thirdly, cash flow rights have different relations with earbning quality in the zones. When the proportion of controlling rights exceed 70%, Dividend gains will be gained by earning management. So, ownership is negatively related with earning quality in highy controlled companies.Fourthly, for the first 3 zones, the higher deviation extent of the ownership and the controlling rights is, the lower the earning quality is, except when the controlling percentage exceeds 70% . These companies are state-ownedenterprises with small cash gains and more flexibility which leads to higherearning quality.Fifthly, the length of controlling chain is basically negatively related withearning quality, except for the lower controlling zone. Maybe in that zone, thebalanced shareholder percentage leads to the various supervision, whichincreases the earning quality.Sixthly, When the controlling shareholder is the state, significantly negativeeffect is shed on the earning quality.Seventhly, the length of controlling chain is positively related with earningquality for the state-owned companies, which is similar with Fan et al.(2005)and SongZhu (2006) . More controlling chain is caused by the release of thedecision rights. The increase of the controlling rights decreases thegovernment behavior and enhances the earning quality.Eighthly, when controlling percentages of controlling shareholders is addedto model in whole sample,the results shows U-type describes the relationshipbetween earning quality and controlling ownership again.This paper focus on analysis of the controlling shareholders, adjustedRsquare is small. In the future, other controlling variables are recommendedto be added to the regression models and time zone would be dated back tothe past several years to see the changes after 2005 when the Reform ofEquity Separation began.