Earnings Management Surrounding Bond Issues

Through over30years’developing in China, enterprise bond has become the most important way for enterpises to direct finance. This paper focus on the earings management in Chinese enterprise bond market, investigating how it affects the credit ratings and the bond yield spread and its mechanism. This paper expands prior research on earnings management into new territory and demonstrates that firms manage earnings not only around equity offerings but also surrounding bond issuances and investigates the mechanism of interaction between earings management and cost of financing in deep. What’s more, different form the prior research, most of which focus on one specific kind of enterprise bond, the sample of this paper covers3comparable kinds of bonds including enterprise bond, corporate bond and MTN.First, the empirical study on data from listed companies during2008to2013indicates significant income-increasing earnings management prior to bond offerings. Then this paper exams the effect of earning management on the credit ratings and the cost of debt. The sample includes corporate bonds, enterprise bonds and MTN issued during2002-2013. The result shows that:(1) for the credit ratings, the discretionary accruals computed Dechow&Dichev model is significant positively related to credit rating, but the result can not be found when computing by Modified Jones model. So there is not enough proof supporting the hypothesis that earings management will increase credit ratings.(2) for the bond yield spread, firms that manage earnings upward issue debt at a lower cost, after controlling for various bond issuer and issue characteristics as a whole. But Specifically, the yield spread of enterpise bond is positively related to the the discretionary accruals while for the corporate bond, the result is on the contrary and what’s more, there isn’t significant relationship between the earnings management and cost of MTN yield spread. The result above implies that, for the enterpise bond, bondholders fail to see through the inflated earnings numbers in pricing new debt, earings management can lower the cost of debt as the management expects, but as for the corporate bond the earnings management will be recognized and punished by investors.Besides, further research on mechanism of earing management affecting cost of bond indicates that (1) the Information Asymmetry hypothesis is supported by the empirical result that non-listed firms, firms choosing Inter-Bank Market to issue their bonds, firms with relatively poor audit quality and firm issuing bond with longer maturity have higher possibility to lower their cost of bond by earnings management. The result also support the (2) Ownership hypothesis by finding that state-owned enterprise and firms issuing Chinese City Construction Investment Bonds can reach the purpose for lowering the cost of bond by earnings manipulation.