Earnings Management of Chinese Listed Firms: Discretionary Accruals and Earnings Benchmarks

This paper examines how earnings benchmarks of firms listed in Mainland China may lead to earnings management through use of discretionary accruals. We compared discretionary accrual levels of small profit firms and small loss firms before and after controlling for the effect of two published benchmarks. We find that firms beating or missing both earnings level benchmark and earnings change benchmark tend to save discretionary accruals, while firms missing either of these benchmarks might employ extra discretionary accruals to meet the other earnings benchmark. Small loss firms reporting a bigger earnings increase might have driven accounting accruals up, and as a result small loss firms as a whole appear to have a high level of discretionary accruals not significantly different from small profit firms. Our findings provide direct evidence for earnings management of listed firms, and also give a reasonable explanation for the "kink" in earnings distribution.