Share pledge and earnings persistence: evidence from China

Abstract

ABSTRACTThis paper studies the effect of share pledges on earnings persistence and the mechanism that explains the effect. We find that both the existence of share pledges and the percentages of pledged shares are negatively related to firms’ earnings persistence, and the results are robust to the DID analysis. Our results indicate that firms with share pledges are more likely to engage in upward earnings management, resulting in diminished earnings persistence. We further find that the negative effect of share pledges on earnings persistence is most significant among non-SOEs, followed by local government-controlled SOEs, and insignificant among central government-controlled SOEs. The effect is mitigated when firms are subject to better audit monitoring or have higher institutional ownership.KEYWORDS: Share pledgeearnings persistenceearnings management AcknowledgmentsWe thank Dr. Jie Wang from Xi’an University of Posts & Telecommunications for his excellent work of data processing and the formation of the research structure.Disclosure statementNo potential conflict of interest was reported by the authors.Notes1. Controlling shareholders are defined as shareholders who possess the ultimate decision making of the firms (Pang and Wang Citation2020).2. This statistic comes from Table 1 of this paper.3. This statistic comes from Table 1 of this paper.4. A-shares are the publicly traded stock shares of mainland China-based companies.5. ST is Special Treatment. If a firm is listed with ST label, it indicates the firm received a risk warning by the stock exchange. ST* indicates delisting risk.6. We also performed coefficient correlation analysis. The result is available upon request.7. Due to space limitations, the following tests show the results of only the dependent variable CROA. The results of the dependent variable ROA are consistent with the results of CROA.8. We also performed robustness tests such as the Heckman two-stage estimation, propensity score matching and using alternative measures of earnings persistence (including the autoregressive model of earnings per share, the DD model, and a relaxed measurement period of earnings persistence in model (1) to t + 2 and t + 3.) The results are available upon request.9. We use the Discretionary Accrual (DA) to measure the degree of earnings management. We first follow Jones (1991)’s model and run following regression.TAi,t=NIi,t−CFOi,t （6–1）TAi,tAi,t−1=β11Ai,t−1+β2ΔREVi,tAi,t−1+β3PPEi,tAi,t−1+εi,t （6–2）In the model, for firm i, NIi,t is net income of year t. CFOi,t is net cash flow of operations of year t. PPEi,t is value of property, plant, and equipment at the end of year t. Ai,t−1 is total assets at the end of year t-1. Δ REVi,t is core business revenue of year t minus it of year t-1. Then we follow Dechow, Sloan and Sweeney (1995) to calculate DA. The model is as follows:DAi,t=TAi,tAi,t−1−β1ˆ1Ai,t−1−β2ˆΔREVi,tAi,t−1−ΔRECi,tAi,t−1−β3ˆPPEi,tAi,t−1 （6–3）Δ RECi,t is receivables of year t minus it of year t-1.10. A regulation issued by the Ministry of Finance of China in 2002 requires that state-owned shares of listed SOEs can be pledged for loans only to listed firms themselves or to their subsidiaries. This regulation is available at http://www.gov.cn/gongbao/content/2002/content_61623.htm.11. The percentage is estimated using our sample. Gul, Kim, and Qiu (Citation2010) estimate 7.3% of Chinese firms hire Big 4 auditors, which is similar to our estimation.Additional informationFundingThe work was supported by the National Natural Science Foundation of China [71773027]