The Earnings Quality Of Local Star Firms:Relationship,Political Connection Reliance Or Market Pressure

Since literatures found there are relationship-based rules working well in some economies, the differences and supplements of relationship-based and marked-based rules become interesting to many studies. However, there is little studies focus on it because of the difficulty in measuring Guanxi. Inspired by Cheung et al.(2005), this dissertation tries to find another strong relationship between companies and local governments under the special Chinese political and economic system, which differs from the classic measurement of political connection proposed by Shleifer and Vishny. Therefore, in this dissertation, it selects local star firms which play an important role in the development of local economic to contrast two competing forces in earnings equality. On one hand, the relationship with local government mitigates local star firms’concern of high quality of corporate governance and financial statements. On the other hand, the market forces such as analysts and auditors can help to constrain earnings management and weaken the information asymmetry to some extent.Using a sample of2084firms listed in Shanghai and Shenzhen Stock Exchange over ten-year period of2003-2012, this dissertation examines the auditor choice and earnings quality, measured by the absolute value of discretionary accruals, abnormal non-core earnings and earnings response coefficient, of local star firms influenced both by the Guanxi and market forces. And whether the market rules designed can balance the earnings and governance problems resulted by the strong relationship between the company and local government.The results show that the local star firms have significantly less probability to choose big-4and higher earnings management measured by the absolute value of discretionary accruals. This is consistent with the hypothesis that the relationship with local government will mitigate the concern of high quality of corporate governance and financial statements of local star firms. When introducing the market control of earnings quality including analyst and big-4auditors, it finds that either analyst follow or big-4auditors cannot improve the high-quality auditor demand or earnings quality of local star firms significantly. However, the earnings management of these firms is no longer significantly high. When separate the sample into local star firms and non-local star firms further, the results show that the joint effect of analyst and big-4can decrease the earnings management and improve the earnings quality of local star firms significantly.