Download Management & Engineering Executives Owning Shareholdings

Management & Engineering 08 (2012) 1838-5745
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Management & Engineering
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Empirical Research on the Earnings Manipulation Behavior of the
Executives Owning Shareholdings
Cui ZHAO 1, 2, , Li’na PEI 3
1. Hebei University of Economics and Business, 050061, P.R.China
2. PHD Candidate of Hebei University, 071002, P.R.China
3. Langfang Yanjing Polytechnic Institute, 065200, Hebei, P.R.China
KEYWORDS
ABSTRACT
Executives owning shareholdings,
Earnings manipulation
With China's state-owned enterprises accomplishing share-trading reform and capital markets
perfect constantly, more and more executives of a listed company became shareholders. The
problem of manipulating profits by executives owning the listed company’s shareholdings has
been being paid more and more attention. According to some of existing research, executives
would manipulate profits in order to maximize their own interests while they hold companies’
shareholdings. Based on this, two samples are selected according to the A–share market where
executives hold actual shares and stock options respectively from 2007 to 2009. We make an
inspection on the relationship between executives’ shareholdings and the earnings
manipulation of the listed company by using the linear regression method. As a result, the
behavior of the earnings manipulation by executives owning shareholdings in listed
companies indeed exists.
© ST. PLUM-BLOSSOM PRESS PTY LTD
1 Introduction
In order to impel executives for the maximization of companies’ value and the reduction of Principal-agent cost between business
owners and Business Managers, the listed company introduces into the mechanism of equity incentive. Compared with ideal situation,
there are some differences when executives’ incentive is carried out. To maximize personal benefit, executives manipulate surplus
and adjust the company’s share price by using the information superiority. Based on the above considerations, this paper studies the
earnings manipulation behavior of the executives owning shareholdings, providing the basis for the improvement of the governance
mechanism.
2 Literature Review
There is a linear relationship between the executives’ shares and earnings manipulation both at home and abroad. Warfield (1995)

Corresponding author.
E-mail address: [email protected]
English edition copyright © ST. PLUM-BLOSSOM PRESS PTY LTD
DOI:10.5503/J.ME.2012.08.009
61
points out that, more stocks held, less the cost of the agent and less the possibility of earnings manipulation. Vernon and James (2002)
shows that, the level of the company earnings management in long-term incentive schemes is low. To study the relationship between
equity structure in listed companies and earnings management, Li changqing, Guan lianyun (2004) put 1262 observation value
among 3 years in 421Shanghai listed companies as a sample and conclude that there is negative correlation between executives’
shareholding and earnings management.
Other scholars believe that there is nonlinear relationship between the executives shares and earnings manipulation. Teshima and
Shuto (2005) use Japanese companies as samples to verify their relation. The result shows that interests’ convergence effect and
defense effect exist at the same time and there is three times in nonlinear relation between management equity and discretionary
accruals. According to the framework of abnormal accruals and modified Jones model, Mao hongan (2008) used listed companies’
data in the year 1995-2004 to analyze that listed companies’ management equity effect earnings quality with the choice of accounting
policy.
Throughout the literature, about the relationship between executive ownership and earnings manipulation, scholars’ opinions are
different because of the difference in samples and research variables. Previous achievements provide good basis for later research and
try to give more comprehensive empirical evidence for earnings manipulation.
3 Theoretical Analyses and Research Hypothesis
The hypothesis of ―economic person‖ thinks human's behavioral motive root in the economical cause. The economic man is in full
pursuit of material benefits for the purposes of economic activity. People want to pay as little as possible, maximizing the harvest and
by hook or by crook. As the economics of the "rational man", executives manipulate earnings to gain more bonuses or obtain a higher
income by raising the share price. Based on the previous studies, this paper divides stocks executives hold into two types——actual
shares and stock options, making empirical analysis correspondingly.
Firstly, executives holding actual shares can both gain bonuses according to their shares and as a stock owner can sell shares in the
stock market. So to maximize their own interest, they tend to manipulate earnings. Based on this, propose the hypothesis H1 .
H1 : Executives shareholding where executives hold actual shares and earnings manipulation are positively correlated.
Secondly, to make executives and shareholders have the same interest, listed companies implement equity incentive system and let
executives own companies’ stock. But, because this system is imperfect in our country, executives intended to manipulate companies’
earnings in order to obtain companies’ performance goals. Based on this, propose the hypothesis H 2 .
H 2 : Executives shareholding where executives hold stock options and earnings manipulation are positively correlated.
4 Empirical Tests
4.1 Research design
4.1.1 Sample selection and data sources
Two samples are selected according to the A–share market where executives hold companies’ shareholdings from 2007 to 2009. Then
the primary sample is selected as follow: firstly, eliminate listed companies in finance and insurance industry. Secondly, eliminate
listed companies where executives hold no stock. Thirdly, eliminate listed companies with executives having no annual return.
Fourthly, eliminate listed companies lack of financial data for the truth and integrity in the final conclusion. As a result, there are 35
companies where executives hold actual shares and 92 companies where executives hold stock options. The sample data is from Rui
Si database and the China Securities Regulatory Commission website. SPSS13.0 software is used to process data.
4.1.2 The set of research variables
Research variables include dependent variable, independent variable and control variables.
Table 4.1 Definition table of research variables
Variable type
Variable symbol
Variable definition
Independent variable
M
the ratio of total shares of the company
Dependent variable
DA
Absolute value of discretionary accruals
Executives
control
variables
annual
Executive compensation disclosed by listed
C1
monetary reward
companies
scale
C2
Natural logarithm of annual total assets
Ratio of liabilities to assets
C3
Ratio of liabilities to assets
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4.1.3 Design for the empirical model
Based on the proposed hypothesis, combined with previous analysis and on the basis of domestic and foreign literatures, this paper
should establish regression model.
DA  0  1  M   2  C1  3  C2  4  C3  
(4-1)
DA
In the formula (4-1),
C2
monetary reward;
coefficient;

is discretionary accruals’ absolute value; M is proportion of shareholding;
is natural logarithm of annual total assets;
C3
C1
is executives annual
is Ratio of liabilities to assets;  0 , 1 ,  2 , 3 ,  4 is regression
is system error.
4.2 Non-parametric test to the earnings manipulation of executives holding actual shares and stock options
Two selected samples are relatively independent and the data is not consistent with the normal distribution. So Mann-Whitney U is
used to analyze the difference between the two samples. The null hypothesis is that the two population distributions from the two
independent samples have no significant difference.
Table 4.2 Difference test
DA
Mann-Whitney U
4064.000
Wilcoxon W
4694.000
Z
-0.822
Asymp. Sig. (2-tailed)
0.0411
Grouping Variable: M
The sample we selected is small, so the exact probability of the U statistics. From table 4.2 we know that if the significant level 
is 0.05, the probability p value is less than the significant level  . So the null hypothesis should be rejected. That is, the
distributions of earnings manipulation conducted by executives respectively holding actual shares and stock options are different
significantly.
4.3 Eempirical analysis
4.3.1 Empirical analysis in earnings manipulation of executives holding actual shares
(1) Descriptive statistics of research variables
Table 4.3 Descriptive statistics of research variables
DA
N
M
C1
C2
C3
Valid
35
35
35
35
35
Missing
0
0
0
0
0
Mean
0.062
0.042
1341942.8
21.15
0.460
Median
0.038
0.000
407200.00
21.09
0.462
Std. Deviation
0.052
0.134
2871189.61
1.198
0.209
Skewness
0.705
3.978
4.404
0.647
-0.110
0.398
0.398
0.398
0.398
0.398
Kurtosis
-0.796
16.64
22.063
0.280
-0.364
Std. Error of Kurtosis
0.778
0.778
0.778
0.778
0.778
Minimum
0.001
0.000
10000
19.046
0.018
Maximum
0.172
0.683
16200000
24.391
0.907
Std.
Error
of
Skewness
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From table 4.3, there’s no difference between the median and the mean of discretionary accruals in the sample. And the slope is 0.705,
greater than zero and to the left. The kurtosis is -0.796, less than zero and lowers than that of the standard normal distribution N (0, 1).
That is, the distribution of discretionary accruals is more focused and discretionary accruals in every company have small
differences.
The standard deviation of executives’ shareholding proportion is 0.134, having some difference compared with the median and the
mean. That is, the distribution of executives owning shareholdings is discrete. The slope is greater than zero and to the left. The
kurtosis is 16.649, greater than zero and higher than that of the standard normal distribution N (0, 1). We can see that the distribution
of executives owning shareholdings isn’t uniform and the ownership is generally low.
The median and the mean of Executives annual monetary reward are different. The slope is greater than zero and to the left. The
kurtosis is 22.063, higher than that of the standard normal distribution N (0, 1). The minimum and maximum vary greatly. That is,
there’s great difference among Executives annual monetary reward of every company and the distribution isn’t concentrated.
The slope of the scale in the sample companies is 0.280, greater than zero and to the left. Its maximum (24.391) and minimum
(19.046) have no difference. That is, every company’s scale is different and the distribution is discrete.
Compared with the median and the mean, the standard deviation of the ratio of liabilities to assets has little difference. That is, the
distribution of the sample’s ratio of liabilities to assets is concentrated and the dispersion is lower.
(2) The empirical results and analysis
Table 4.4 Regression coefficient and significant test table (Coefficients)
Model
1
Unstandardized
Coefficients
Standardized Coefficients
B
Std. Error
Beta
(Constant)
0.189
0.182
M
0.400
0.489
C1
-2.901
C2
C3
Dependent Variable:
T
Sig.
1.013
0.031
-1.038
0.219
0.017
0.003
-0.161
-0.803
0.427
0.005
0.009
0.151
0.723
0.025
-0.032
0.043
-0.131
-0.341
0.045
DA
From table 4.4, we can conclude the result of regression coefficient and significant test.
The probability of the constant
t
value is lower than 0.05, having obvious difference with zero. That is, the constant term should
appear in the equation.
t
The probability of the executives’ shareholding proportion
value is lower than 0.05, the constant term having obvious difference
with zero. That is, executives’ shareholding proportion should appear in the equation as independent variable.
The probability of the Executives annual monetary reward
t
value is higher than 0.05, its coefficients has no obvious difference
with zero and it isn’t associated with executive ownership. That is, the Executives annual monetary reward should not appear in the
equation.
The probability of the natural logarithm of total assets
t
value is lower than 0.05, its constant term is significantly different from
zero. That is, total assets should be explanatory variable and appear in the equation.
The probability of
t
value is lower than 0.05, its constant term is significantly different from zero. That is, The Ratio of liabilities to
assets should be explanatory variable and appear in the equation.
4.3.2 Empirical analysis in earnings manipulation of executives holding stock options
(1) Descriptive statistics of research variables
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Table 4.5 Descriptive statistics of research variables
DA
M
C1
C2
C3
Valid
247
247
247
247
247
Missing
0
0
0
0
0
Mean
0.086
0.126
2688944.753
21.769
0.453
Median
0.052
0.006
1627700.000
21.584
0.447
Std. Deviation
0.104
0.193
3601729.100
1.218
0.217
Skewness
2.778
1.475
4.192
0.411
3.648
Std. Error of Skewness
0.155
0.155
0.155
0.155
0.155
Kurtosis
10.134
1.103
24.149
-0.381
35.682
Std. Error of Kurtosis
0.308
0.308
0.308
0.308
0.308
Minimum
0.001
0.000
53200
18.916
0.018
Maximum
0.731
0.724
32520000
24.948
2.567
N
From table 4.5, the median and the mean of the discretionary accruals have little difference. That is, the distribution is concentrated
and every discretionary accrual has little difference. Its slope and kurtosis is 2.778, 10.13, greater than zero, higher than that of the
standard normal distribution N (0, 1).
The standard deviation of executives’ shareholding proportion is 0.193, having little difference from the median value. That is, the
distribution of executives owning shareholdings is not discrete. The slope is greater than zero and to the left. The kurtosis is 1.103,
higher than that of the standard normal distribution N (0, 1). We can conclude the distribution of executives owning shareholdings
isn’t uniform and the ownership is generally low.
The kurtosis is 22.063, higher than that of the standard normal distribution N (0, 1). The minimum and maximum vary greatly. That
is, there’s great difference among Executives annual monetary reward by every company.
There is a small difference from the mean and the median, their values are 21.769, 21.584. But its Standard deviation (1.218) has
little difference relatively. That is, every company’s scale is different largely. The slope of the scale in the sample companies is 0.411,
greater than zero and to the left. Its kurtosis is -0.381, less than zero, lower than that of the standard normal distribution N (0, 1).
Compared with the median and the mean, the standard deviation of the ratio of liabilities to assets has little difference. That is, the
distribution of the sample’s ratio of liabilities to assets is relatively concentrated and the dispersion is lower.
(2) The empirical results and analysis
Table 4.6 Regression coefficient and significant test table (Coefficients)
Model
1
Unstandardized
Coefficients
Standardized Coefficients
B
Std. Error
Beta
(Constant)
0.037
0.018
M
0.123
0.036
C1
0.000
C2
C3
Dependent Variable:
T
Sig.
2.069
0.040
0.229
3.411
0.001
0.000
-0.036
-0.479
0.632
0.001
0.001
0.008
0.102
0.049
0.079
0.033
0.165
2.374
0.018
DA
From table 4.6, we can conclude the result of regression coefficient and significant test.
The probability of the constant
t
value is less than 0.05, having obvious difference with zero. That is, the constant term should
appear in the equation.
t
The probability of the executives’ shareholding proportion
value is 0.001, less than 0.05, the constant term having obvious
difference with zero. That is, executives’ shareholding proportion should be explanatory variable and appeared in the equation.
The probability of the Executives annual monetary reward
t
value is greater than 0.05, its coefficients has no obvious difference
with zero and it isn’t associated with executive ownership. That is, the Executives annual monetary reward should not appeared in the
equation.
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The probability of the natural logarithm of total assets
t
value is less than 0.05, its constant term is significantly different from zero.
That is, total assets should be explanatory variable and appeared in the equation.
The probability of the Ratio of liabilities to assets
t
value is less than 0.05, its constant term is significantly different from zero.
That is, total assets should be explanatory variable and appeared in the equation.
5 Regression Analyses
5.1 The relation between executives shareholding proportion and earnings manipulation degree
Whether executives hold actual shares or stock options, it is verified through empirical analysis that there is significantly positive
correlation between executive ownership and earnings manipulation in Chinese listed companies. That is, the degree of the equity
incentive in Chinese listed companies cannot put executives into shareholders’ position. Conversely it stimulates executives to
manipulate earnings for their own income.
5.2 The relationship between the monetary reward of executives and earnings manipulation
There is non-significant correlation between executives’ annual monetary reward and earnings manipulation. Because there isn’t high
correlation among net profit and executives’ annual monetary reward in Chinese listed companies. And the ratio of executives’
shareholding is lower and the degree of equity incentive in listed companies is lower. So the incentive is invalid for executives. They
often intend to grab some hidden income like excessive consumption, not manipulate earnings to maximize their own interest.
5.3 The relationship between firm size and the earnings manipulation
Through empirical analysis, there’s a positive correlation between company scale and the degree of earnings manipulation. It’s
consistent with the foregoing analysis results. The larger companies are, the more focus on companies by government and public
interest. Then higher the political cost is, more tax would be bear. To avoid this situation, executives would defer earnings to the next
one or several periods so as to reduce current profit and reduce the political cost. Larger the listed company is, more complex the
internal organizational structure is. Because of information asymmetry, executives’ behavior cannot be observed by external
stakeholders and the possibility of earnings population is larger.
5.4 The relationship between the rate of assets and liabilities and earnings manipulation
According to the empirical analysis, there’s negative correlation between the rate of assets and liabilities and earnings manipulation
where executives hold actual stocks. It is not consistent with the foregoing theoretical analysis. The higher ratio of liabilities to assets
shows that this company has stronger debt financing ability and have stronger solvency. Creditors tend to trust this kind of companies
and believe executives wouldn’t manipulate earnings. Whereas, there’s positive correlation between the rate of assets and liabilities
and earnings manipulation in which executives hold stock options. It is consistent with the foregoing theoretical analysis. Because of
companies’ debt pressure, executives would manipulate earnings to ease companies’ debt problem. That is, there’s correlation
between the rate of assets and liabilities and earnings manipulation. The rate of assets and liabilities is different and the effect to
earnings manipulation is different.
6 Conclusion
The empirical result shows that the behaviors of earnings manipulation by executives holding stocks do exist. And the higher ratio of
executives’ shareholdings is, the more degree of the earnings manipulation is. That is, the incentive to executive in Chinese listed
companies cannot develop long-term constraint effect, but stimulate executives to manipulate earnings to increase their own income.
References
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on the Equity Incentive——From Chinese Listed Companies’ Empirical Evidence. Accounting Communications, 2010: 18 (in
Chinese)
[3]. MAO Hongan. The Management Equity, the Choice of Accounting and Earnings Quality. Accounting Communications
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