The Financial Reporting Practices of State-Controlled Firms: Evidence from China

This paper examines the impact that state ownership has on the financial reporting practices of publicly traded firms. 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 the underlying government and the structure of the state’s ownership shape financial reporting practices. We find that the reported earnings of state-controlled listed Chinese firms display minimal timely loss recognition properties over the period 1993 to 2003. Despite the overall low levels of conditional conservatism observed, there exists significant cross-sectional variation in reporting practices conditional on the underlying governments’ incentives and market structure. First, we find that managers afforded greater autonomy through the use of pyramidal ownership structure have better reporting practices. Second, we find that the asymmetric timeliness of earnings is strongest among those firms that are operating in provinces with weak investor protections, minimal deregulation of the marketplace, and are broadly seeking to maximize social outcomes (e.g., full employment concerns). Lastly, we find that significant TLR practices are concentrated among those firms controlled through a multi-layer pyramidal ownership structure and operate in environments with weak protections, limited market deregulation and poor economic performance. Thus, in those environments characterized by a high likelihood of bad outcomes, the pyramidal ownership arrangement induces the timely recognition of economic losses. In contrast, in those regions with good economic performance, strong investor protections and viable markets, multi-layer pyramids do not produce an incentive for TLR.