A Study On The Relationship Between Political Connections And Earnings Management In Chinese Private Listed Firms

The market system and related institutions is not perfect when under Transition Economies. More and more private firms adopt a political strategy by hiring people who has a political connections or using the political connections of human capital, to gain more benefits and opportunities. They always choose to hidden the profits to avoid being concerned, or just leading earnings management for the tax when they obtain high profits. So, it is a question worth thinking that if inclusive political connections could affect earnings management. Therefore, this paper has focused on the relationship between political connections and earnings management under different situations.This paper defines and analyzes the concept of political connections and earnings management firstly, then discussed the theoretical basis between political connections and earnings management based on the principal-agent theory, asymmetric information theory, social capital theory and resource dependence theory. Afterward describes and analyzes the development and current political connections of private listed firms, as well as the modes to build relations with government and the motivations of earnings management. In the empirical part, this paper selects 1357 observations of A-share private companies listed in Shanghai and Shenzhen Stock. In the study, this paper divided into six parts to investigate the relationship between political connections and earnings management in private listed firms under different conditions. And the paper adopted adjusted modified cross-sectional Jones model to measure earnings management, while using descriptive statistics and multiple linear regressions methods to investigate the empirical part. And the empirical results show that compared with companies without political connections:(1) the firms that have political connections are more likely to have significant negative earnings management behaviors; (2) the firms that have strong political connections are more likely to have significant negative earnings management behaviors; (3) political connections of different position has different effect on earnings management, and the correlation between political connections and earnings management is in descending order according to actual controller, president and general manager; (4) In the private firms, the dual power have significant positive effect on the relationship between political connections and earnings management; (5) the level of political interventions in local government has significant positive effect on the relationship between political connections and earnings management; (6) the level of local economic surplus has significant positive. effect on the relationship between political connections and earnings management.Finally, according to the results of the theoretical analysis and empirical testing, some governance suggestions have been given for the constraints of listed firms’ earnings management behaviors:improving the market and governance institutions, and establishing a perfect market system; building effective external supervise mechanisms to strengthen the constraint and punishment; improving the effectiveness of the capital market, and increasing transparency of information; building perfect mechanisms to enhance the independence of the independent directors; strengthening the construction of independence of executive positions; dispersing equity moderately.