Research On The Impact Of Political Connections On Earnings Management Of Private Enterprises

At present, the reform of our country has entered the deep waters, and the transformation of the government functions has become one of the most difficult tasks. The report of the18th National Congress of the Communist Party of China (NCCPC) states that "we should separate government administration from the management of enterprises, state assets, public institutions, and social organizations, and build a well-structured, clean and efficient service-oriented government that has scientifically defined functions and satisfies the people."That highlights the Party Central Committee’s determination aimed to realize the transformation of government functions, but reform will not be achieved overnight, moreover the government putting its"visible hand"in place needs time. The government still plays a dominant role in social economy, and still plays the role of social resource allocation. Therefore, in order to obtain economic resources and policy support, many enterprisesnarrow the gap between government and enterprises through building political connections as their strategic choice. Relative to the state-owned enterprises, private enterprises in our country, locate at the end of the institutional master-slave order, and remaindisadvantageous in market competition, thus private enterprises have more motives to improve their operating environmentby building a political connection. Therefore, inquiry of the phenomenon of political connections of private enterprises in our country has more realistic significance.In fact, the phenomenon of private enterprises’ political connections with the government has become so common. Private entrepreneurs participating in the administration and discussion of state affairs has become a common practice through standing for election of the Party representative, the deputy to the National People’s Congress(NPC), or the member of the Chinese People’s Political Consultative Conference(CPPCC); additionally, they also employ incumbent or former government officials in an attempt to build these connections. A large number of studies have shown that a private enterprise, by building a political connection, can obtain the advantages of resource allocation and the property right protection, and ultimately affect the enterprise value. But previous studies following the logic of "political connectionsâ†'resource allocation/property protectionâ†'private enterprise value", neglect the intermediate variable of accounting information. Accounting information is not only an important parameter in enterprise value evaluation, but also a significant basis for resource allocation and definition of property rights. The earnings management is the important factor affecting the quality of accounting information. In a word, we believe the mechanism how the political connections affectsthe value of private enterprises should be "political connectionsâ†'earnings managementâ†'the quality of accounting informationâ†'resource allocation/property protectionâ†'private enterprise value". Therefore, starting from the starting point of the logic of thinking, we investigate the influence of political connections on earnings management to clarify how political connections affects resource allocation/property protection, which further affects the transmission mechanism of the enterprise value. This investigation undoubtedly has important theoretical and practical significance.Based on the related literature which was analyzed and reviewed in this dissertation, we systematically drew on reputation theory, resource dependence theory and property rights theory, adopted the method of combining normative research and empirical research. Private listed companies from2009to2012in Shenzhen small and medium-sized (SME) stock market were chosen as the research object to explore whether and how political connections affect earnings management in a comprehensive manner. Specifically, first of all, rooted in the background of the Chinese institution, we conducted an in-depth analysis of China’s private enterprises in different stages of development, basic development policies and regulations, and political connections; second, it is comprehensively used reputation theory, resource dependence theory, and property rights theory etc. to examine the influence of the political connections on private enterprise earnings management; again, we thoroughly investigated the nature of political connections, analyzed the existing measurement method of political connections from the perspective of its advantages and disadvantages, by using of the Analytic Hierarchy Process (AHP) to construct the political connections index model of private enterprises; then, introducing marketization variables, Lu Jianqiao (1999) extended Jones model were used to measure earnings management and test the influence of political connections on the degree of earnings management of private enterprises; then, we drew on Lu Jianqiao (1999) extended Jones model and Roychowdhury (2006), Li Bin et al.(2009) model of real activities manipulation respectively to measure accrued earnings management and real earnings management and test the influence of political connections on methods of earnings management of private enterprises; finally, on the basis of theoretical analysis and empirical research, we came to the following conclusions and corresponding suggestions were also put forward.The main conclusions and points of views of this dissertation are as follows:1. The political connections of private enterprises in different stages of development present different characteristics:in the rapidly contracting stage (1949-1956), the first batch of private entrepreneurs participated in the administration and discussion of state affairs through CPPCC. Then, along with the advancement of socialist transformation, private enterprises and private entrepreneurs disappeared, so political connections phenomena was gone with them; in the tortuous recovery stage (1978-1991), because of the reform and opening up, private enterprises gradually recovered. Due to the fact that the national policy changed frequently, private enterprises commonly adopted the way of "red hat" to protect themselves; in the rapidly expanding stage (1992-2001), due to the rapid development of private enterprises, the political connections was mainly related to "red hat", government officials who quit to pursued business success, and private entrepreneurs participated in the administration and discussion of state affairs through standing for election of a member of NPC or CPPCC; in the steady development stage (2002-present), private enterprises developed steadily and healthily, and political connections was mainly embodied in government officials who quit to pursued business succiss, and private entrepreneurs participated in the administration and discussion of state affairs through standing for election of a member of NPC,CPPCC, or Chinese Communist Party Congress. And many private entrepreneurs took positions at all levels of the Party Committee, NPC and CPPCC.2. On the basis of a thorough analysis of existing literature, and combining the institutional background of our country, the political connections has the essential characteristics of "hierarchy","accumulation" and "timeliness", etc. We also pointed out the deficiency of measurement method, and on this basis we construct political connections index system according to characteristics of China’s private enterprises corporate governance, then with the aid of Analytic Hierarchy Process (AHP) and yaahp V6.0software on each index weight assignment, thus to build a political connections index model of private enterprises. Finally we chose the2012Shenzhen small and medium-sized plate of10having a political connection of private listed companies, and construct index model was used to calculate the political connections index. Results showed that although the10listed private companies have political connections, but significant differences exist among political connections index of different companies. It shows strength differences does exist in the political connections, and further suggests that traditional methods such as virtual variable method, the assignment method etc. can not effectively measure the strength of the political connections.3. We used the private listed companies from2009to2012in Shenzhen SME stock market as empirical data to test the impact of political connections on the degree of earnings management of private enterprises. The results prove that political comiections does has a positive influence on the degree of earnings management, especially in areas of low marketization in which political connections has more significantly positive impact on the degree of earnings management. Specifically, political connections phenomenon is common in the private listed companies of our country; relative to the east coast, political connections phenomenon in mid-west is more common and the connections intensity is greater; political connections significantly affects the degree of earnings management of enterprises, and the level of earnings management of private listed companies that have political connections is significantly higher than private listed companies without political connections; political connections with intensity difference, the greater the intensity of political connections of the private listed companies, the greater the degree of earnings management. Marketization has a negative effect on earnings management, but the influence is mainly by political connections indirectly play a role, namely, the lower the degree of marketization, the political connections of private listed companies on the impact of the degree of earnings management, the more significant.4. We used the private listed companies from2009to2012in Shenzhen SME stock market as empirical data to test the impact of political connections on the methods of earnings management of private enterprises, and to verify private enterprises in China whether there is a choice of the methods of earnings management preferences under the action of political connections. The results showed that the greater intensity of political connections of private enterprises, the higher accrued earnings management is, and the lower degree of sales control, production control, cost control degree, as well as the total real earnings management. This showed that private listed companies in China exists methods preference of earnings management, in the cases without political connections, especially in the areas of higher marketization, accrued earnings management of private listed companies are subjected to many constraints, therefore, private listed companies are more likely to choose real earnings management; and in the cases with political connections, especially in areas of lower marketization, accrued earnings management of private listed companies private listed companies earnings management are subjected to less constraints, so private listed companies are more likely to choose accrued earnings management.The possible innovations of this dissertation mainly are:first, it is comprehensively used the theoretical system comprising reputation theory, resource dependence theory, and theory of property rights theory to examine the mechanism of the influence of the political connections of earnings management so as to enrich the theoretical system of political connections with earnings management to some extent, providing theoretical support for the subsequent empirical research; second, we put forward the political connections with the essential characteristics of "hierarchy","accumulation" and "timeliness",etc, analyzed political connections and the advantages and disadvantages of the existing measurement methods, and on this basis considering China’s institutional background and characteristics of China’s private enterprises corporate governance, political connections index model of private enterprises was constructed using Analytic Hierarchy Process (AHP) system, thus to expand the political connections measurement; third, introducing variable marketing degree, the integrated use of Lu Jianqiao (1999) extended Jones model and Roychowdhury (2006), Li Bin et al.(2009) model of real activities manipulation of the test of a political connections on the degree and the methods of earnings management of private enterprises, thus to enrich and complement the research of relationship between political connections and earnings management.The limitations of this dissertation mainly are:first, because of the construction of political connections index system showed subjectivity and Analytic Hierarchy Process (AHP) is also a kind of subjective assignment method, on which the political connections index model of private enterprises was built. So it is also hard to avoid subjectivity; second, in this dissertation, we conclude that the political connections of private enterprises are dominant, easy to be identified. But in reality, in addition to the dominant political connections, there are many hidden political connections. Relationship with government officials, such as relatives, friends, classmates or pure interest exchange relationship, can also build political connections. The political connections are informal, private, and not easy to be identified; at last, this dissertation only examined the influence of the political connections of private enterprises on the degree of earnings management and the mechanism was also studied. Because of the space limitation, we did not go further to investigate the political economic consequences associated with earnings management. We hope that these deficiencies can be supplemented and perfected in the future research.