Political Incentives to Suppress Negative Financial Information: Evidence from State-controlled Chinese Firms

This paper examines the impact that political forces have on the flow of negative financial information into stock prices. Using a unique sample of listed Chinese firms ultimately controlled by local and/or provincial government entities, we test the proposition that the incentives of politicians and the local government shape financial reporting practices, especially with respect to the release of information about bad outcomes. We examine the flow of negative information around three visible political events: The National Congress of the Chinese Communist Party, provincial-level promotions, and the revelation of provincial-level corruption investigations. We find that statecontrolled firms are significantly less likely to experience negative stock price crashes in the years of the National Congress of the CCP and in advance of political promotion decisions. Further analyses reveal that the suppression of negative information around National Congress meetings is a countrylevel phenomenon, while political promotion events produce local incentives to suppress negative information. These promotion effects are strongest in those regions where (a) meaningful capital market development, (b) strong performance expectations and (c) high levels of foreign investment raise the political and reputation costs of reporting financial performance. Overall, our results highlight the important role that political forces play in shaping financial reporting incentives of state-controlled entities.