Chinese Tango: Government Assisted Earnings Management
Xiao Chen
School of Economics and Management, Tsinghua University
Chi-Wen Jevons Lee
A.B. Freeman School of Business, Tulane University
School of Economics and Management, Tsinghua University
Jing Li
School of Business and Management, HKUST
Dec, 2003
Correspondence: Chi-Wen Jevons Lee, A.B. Freeman School of Business, Tulane University, New
Orleans, LA, 70118-5669, USA Jevons.lee@tulane.edu, Tel: (504) 862-8485
ABASTRACT: In a Socialist market economy like China, the relations between
various layers of government and state-owned enterprises are tangled. When the
Socialist system embraces the market economy, it creates many facets of interest
conflict and goal incongruence. This paper describes the collusion between local
government and state-owned enterprises in conducting earnings management to
circumvent central government regulation, a phenomenon known as Chinese Tango.
Our study shows that local government actively participates in earnings management
of the listed firms by providing fiscal transfers. The primary purpose of this
government-assisted earnings management is to assist the firms to manage accounting
earnings to meet the regulation stipulated by the central government.
Keywords: Local taxation; fiscal transfers, rights offering; earnings management;
returns on equity (ROE)
Data Availability: Data are available from sources identified in the paper
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1. INTRODUCTION
Transforming socialist system into a market economy has been China’s most important
policy since 1978. To facilitate market-based corporate financing, China established stock
markets in Shanghai and Shenzhen.1 In a “socialist market economy,” the relations between
the state-owned enterprises (SOE) and various layers of government are entangled, with many
facets of interest conflict and goal incongruence. The purpose of this paper is to study the
three-person game of central government, loca