An appraisal of financially distressed companies' earnings management

Abstract Purpose – This study aims to examine the earnings management behaviour of financially distressed listed companies in China for the period 2002‐2006. Design/methodology/approach – The present study uses discretionary accruals to serve as a proxy variable for earnings management, with the type of ultimate ownership and the type of industry to which the company belongs functioning as independent variables. Findings – The empirical results show that the desire to avoid continued special treatment (ST) status and the risk of being de‐listed leads firms to adopt different earnings management behaviour before and after being designated as an ST firm. Research limitations/implications – The desire to avoid being de‐listed is as strong among managers of state‐owned companies as it is among private companies. Practical implications – Implementing the effective regulation of corporate earnings management is therefore an issue of great importance. It is recommended that the government needs to take the degree of industry regulation into account when assessing regulations aimed at controlling earnings management. Originality/value – In a transition economy like China, the state versus private ownership and the degree of government regulation in industry is likely to affect the earnings management of financially distressed companies. The study demonstrates that companies in less‐regulated industries tend to undertake more earnings management in the years both before and after they are designated as ST companies.