Political Connection,Debt Constraints And Earnings Conservatism

Due to the facts of imperfection of the capital market,the incomplete legal system and the institutional environments in China,establishing political connection to carry out "rent-seeking" has become a common phenomenon in Chinese enterprises.At present,the market allocation of resource is still dominated by Chinese government,the employments of corporate executives with political background will bring the social capital to companies,which help break the trade barriers,attain access to the capitals and the tax privilege.In recent years,both domestic and foreign banks are frequently involved in major financial crisis which severely damaging the banking business.A specific way to avoid the risk of default is needed urgently.Moreover,earnings conservatism can reduce the moral hazards caused by the asymmetric information.Thus,the creditors have a need in companies’earnings conservatism.However,political connection gradually becomes the alternative of accounting information mechanism and resource allocation function,acts as a "grabbing hand".All these will further affect the accounting information quality adversely.Therefore,the research of relationship among political connection,debt constraints and earnings conservatism has important practical significance on how to improve the accounting information quality and protecting the interests of creditors.This empirical study is based on asymmetric information theory,principal-agent theory,reputation theory,incomplete contract theory and creditor governance theory,using the data from A-share listed companies during 2011-2014.The indicator for political connection is selected.The debt constraints are examined in four dimensions:debt scale,debt maturities,debt costs and debt conflict.The appropriate substitution variables are chosen with respect to each dimension.The C-SCORE model developed by Khan and Watts was adopted to measure the degree of fiscal-year specific earnings conservatism.Finally,models to examine the mechanism of political connection,debt constraints and earnings conservatism are built by considering all the factors above.The results indicate that:(1)While enterprises establish political connections and gain access to superior resources,the constraints from corporate parties including shareholders and creditors are reduced as well as earnings conservatism.(2)The creditor governance function can be effectively exerted especially in companies with the larger of debt scale,the shorter of debt maturities,the higher of the debt costs and the greater of the debt conflict.The level of earnings conservatism is higher within these companies.(3)The companies with political connections,their debt constraints show weakened effect on earnings conservatism as appearing in all four dimensions.The evidence supports that the political connection will reduce the governance function of debt constraints on earnings conservatism.Three policy recommendations to improve the accounting information quality are given based on the empirical analysis above:(1)The creditors need to design a reasonable debt covenant,and exert their supervisory function in a long term.(2)The enterprise itself need to establish a scientific way for assessment and appointment of officials,and enhance its creditor governance mechanisms;(3)The government should participate in building a completed capital market with deepening the economic reform.