Table Of ContentDo Principles-based Accounting Standards Matter?
Evidence from the Adoption of IFRS in China
A Thesis
Submitted to the Faculty
of
Drexel University
by
Yongtao Hong
in partial fulfillment of the
requirements for the degree
of
Doctor of Philosophy
April 2008
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Dedications
To my family
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Acknowledgements
First, I would like to express my appreciation to my advisor, Dr. Ndubizu, for his
unconditional supervision and guidance. During the doctoral program, he provided me
with invaluable guidance and advice, both academic and personal.
I also would like to thank to my committee members, Dr. Grein, Dr. Chandar, Dr.
Szewczyk, and Dr. Arinze, for their support and guidance during my time in the program.
I am especially grateful to Dr. Ndubizu, Dr. Grein, Dr. Chandar, Dr. Agoglia, Dr.
Campbell, Dr. Chang, and Dr. Werner for their support and invaluable advice during my
job search. It is them and every other member in this department who make me feel like
living with a family rather than simply working here.
I would like to thank my colleagues, Xiaochuan Zheng, Cathy Beaudoin, and
Tamara Lambert, and all other Ph.D students for their encouragement and friendship
during the rough times. Without your generous help, constant encouragement, and hearty
friendship, it is unimaginable how I could survive in this program.
Finally, I am very grateful to my family: my wife and my daughter. They sacrifice
a lot of family time in supporting my study and research. I owe them a lot in all these
years. Hope I can pay it back somehow, someday.
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Table of Contents
List of Tables.....................................................................................................................vi
List of Figures...................................................................................................................vii
ABSTRACT.....................................................................................................................viii
CHAPTER ONE: INTRODUCTION.................................................................................1
1.1 Objectives and Motivations...................................................................................1
1.2 Contributions of the study......................................................................................4
1.3 Implications of results............................................................................................7
1.4 Organization of the Study......................................................................................9
CHAPTER TWO: LITERATURE REVIEW AND HYPOTHESES...............................10
2.1 Introduction..........................................................................................................10
2.2 Rules-based versus Principles-based Accounting Standards...............................10
2.3 Accounting Reform in China: Rules-based versus Principles-based Standards..12
2.4 Hypotheses Development....................................................................................15
2.4.1 Comparability Hypothesis.........................................................................15
2.4.2 Earnings Smoothness Hypothesis..............................................................16
2.4.3 Earnings Management Hypothesis............................................................18
2.4.4 Relevancy Hypothesis................................................................................20
2.5 Summary..............................................................................................................21
CHAPTER THREE: RESEARCH DESIGN....................................................................22
3. 1 Introduction.........................................................................................................22
3. 2 Data Description.................................................................................................22
3.2.1 Data Collection..........................................................................................22
3.2.2 Sample Procedure......................................................................................24
3.2.3 Sub-sample: State-owned (SOE) and private firms (PE)...........................25
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3.3 Variable Measurement.........................................................................................30
3.3.1 Estimating Comparability..........................................................................31
3.3.1.1 First Approach: No Controls for Volatility Relevant Variables...............31
3.3.1.2 Second Approach: Controls for Volatility Relevant Variables.................33
3.3.2 Estimating Earnings Management.............................................................40
3.3.2.1 Real (Transactions-based) Earnings Management....................................41
3.3.3.2 Accounting (Accruals-based) Earnings Management..............................42
3.3.3 Estimating Value relevance.......................................................................43
3.3.4 Estimating Earnings Informativeness........................................................45
CHAPTER FOUR: RESULTS.........................................................................................48
4.1 Descriptive Statistics............................................................................................48
4.2 Tests of H1 (Comparability Hypothesis).............................................................49
4.3 Tests of H2-4 (Earnings Smoothness Hypotheses)..............................................51
4.4 Tests of H5 (Real Earnings Management Hypothesis)........................................52
4.4 Tests of H6 (Accounting Earnings Management Hypothesis)............................54
4.6 Tests of H7 (Value Relevance Hypothesis).........................................................56
4.7 Tests of H8 (Informative Earnings Hypothesis)..................................................60
4.8 Additional Tests...................................................................................................62
4.8.1. Robustnes Test One: Total Population.....................................................62
4.8.2. Robustness Tests: Industry Samples.........................................................63
4.8.3 Sensitivity Analyses...................................................................................64
CHAPTER FIVE: CONCLUSIONS................................................................................65
REFERENCES.................................................................................................................69
EXHIBITS......................................................................................................................118
APPENDICES................................................................................................................121
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List of Tables
1. Sample and Industry Distribution.................................................................................77
2. Realized Frequency of Digits for Annual Earnings......................................................78
3. Descriptive Statistics.....................................................................................................79
4. Comparing Comparability of Raw Accounting Information in Rules-based versus
Principles-based Accounting Regimes.....................................................................83
5. Comparing Comparability of Accounting Information after Controlling for Volatility
Relevant Factors in Rules-based versus Principles-based Accounting Regimes......84
6. Earnings Smoothness Tests...........................................................................................88
7. Comparing Abnormal Operating Activities in Rules- versus Principles-based
Accounting Regimes.................................................................................................92
8. Univariate Analysis of the Absolute Value of Discretionary Accruals in Rules-based
versus Principles-based Accounting Regimes..........................................................94
9. Multivariate Analysis of the Absolute Value of Discretionary Accruals in Rules-based
versus Principles-based Accounting Regimes..........................................................95
10. Regressions of Stock Price on Earnings Per Share.....................................................97
11. Regressions of Stock Price on Earnings Components per share.................................98
12. Value Relevance of Rules-based and Principles-based Standards...........................100
13. Regressions of Stock Returns on the Change in Earnings Per Share.......................102
14. The Stock Return Based Value Relevance Analysis on Firms with Good or Bad
Return News ...........................................................................................................103
15. Regressions of Future Operating Cash Flows Accumulated One-, Two-, and Three-
years-ahead on Earnings.........................................................................................105
16. Regressions of Future Operating Cash Flows Accumulated One-, Two-, and Three-
years-ahead on Earnings Components....................................................................107
17. Robustness Tests: Population Analysis....................................................................109
18. Robustness Tests: Industry Effect Analysis..............................................................111
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List of Figures
1. Evolution of Chinese GAAP for Listed Firms............................................................115
2. Realized Frequency Comparison between Digit Four an Eight in Reported Earnings116
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ABSTRACT
Do Principles-based Accounting Standards Matter? Evidence from the Adoption of IFRS
in China
Yongtao Hong
Gordian A. Ndubizu, Ph.D.
This paper compares measures of accounting quality for 654 firms that previously
used rules-based Chinese GAAP and have transitioned into principles-based International
Financial Reporting Standards (IFRS) adopted in China. In particular, I examine whether
principles-based standards are associated with less real earnings management, less
comparability, a higher variance of change in net income, a higher ratio of change in net
income to change in cash flows, a significantly lower negative correlation between
accruals and cash flows, more discretionary accruals, higher informative earnings about
future cash flows and higher value relevance of accounting amounts than rules-based
standards. The latter accounting regime fosters more check box or compliance mentality,
provides more detailed implementation guidance, emphasizes more form over substance
and deploys accounting treatments not based on recognizable principles compared to the
principles-based standards. These differences between the two accounting regimes are
likely to affect accounting quality. In an attempt to improve the quality of financial
reporting in the post-Enron era, Section 108 of the Sarbanes-Oxley Act of 2002 instructs
the Securities and Exchange Commission (SEC) to conduct studies on the characteristics
of rules-based and principles-based standards. This request suggests that results of my
study might have implications in U.S. and other countries transitioning from rules-based
to principles-based IFRS.
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The results suggest that principles-based standards have higher accounting quality
than rules-based standards. In particular, I find that principles-based standards have less
comparable accounting numbers, a significantly higher variance of change in net income,
a higher ratio of the variances of the change in net income and change in cash flows, and
a significantly lower negative correlation between accruals and cash flows. Further,
consistent with lower quality, rules-based standards have a significantly more evidence of
real earnings management (financial structuring) and a significantly less discretionary
accruals. The evidence suggests that firms substitute costly real earnings manipulation
with cheaper accounting earnings management as they transition from rules-based to
principles-based standards. In addition, consistent with higher quality, principles-based
standards have significantly higher informative earnings about future cash flows, and
significantly higher value relevance of accounting amounts. This paper also contributes to
the regulatory debate by providing evidence that losses and/or bad news are more value
relevant in the principles-based accounting regime. Findings are similar for state-owned
firms, while private owned firms have similar but weak results.
Description:2.3 Accounting Reform in China: Rules-based versus Principles-based .. favor of the more principles-based IFRS, which emphasizes economic
