From 1996 to 1998, listed companies in China were required to achieve a minimum return on equity (ROE) of 10 percent in each of the previous three years before they could apply for permission to issue additional shares. As a result of this rule, there was a heavy concentration of ROEs in the area just above 10 percent. We show that the Chinese regulators appear to have scrutinized firms using excess amounts of nonoperating income to reach the 10 percent hurdle. In addition, their ability to do so seems to have improved over time, which allows them to be better able to identify firms that subsequently performed better. However, many firms were still able to gain rights issue approval through excess nonoperating income. We show that these firms subsequently underperformed other approved firms that did not use the same practice, indicating that the Chinese regulators' objective of guiding capital resources toward the well-performing sectors is partially compromised by earnings management.

Using China's 2008 four-trillion-yuan economic stimulus as a setting and proprietary loan data, we study how a large publicly listed state-owned bank responds to the government's countercyclical financing initiative while trying to meet the expectations of bank regulators and public investors. We find that the bank exhibited little changes in the process of setting internal credit ratings of borrowers, and internal ratings remain a valid, albeit weaker, predictor of interest rates in the stimulus period. Interest rates also remain a valid predictor of loan delinquency in the stimulus period. Evidence from analyzing unlisted borrowers is broadly similar. Overall, there is no systematic evidence that loan decisions of the state-owned bank are severely compromised in the stimulus period. The study adds to the limited understanding of how partially privatized state-owned banks balance different objectives in managing credit risk and is relevant to the longstanding debate over the roles of state-owned banks.

Since the Split Share Structure Reform took effect in China in 2005, holders of nontradable shares (controlling shareholders) have had to negotiate with holders of tradable shares (minority shareholders) to gain the liquidity right. In a typical deal reached, the controlling shareholder agrees to pay share compensation to minority shareholders and, in many cases, also pledges to meet a specific firm performance target (performance commitments). Using this reform setting, we examine the impact of performance commitments on earnings management behavior, and find the following results. First, less profitable firms have greater incentives to make performance commitments that help to reduce the share compensation that controlling shareholders have to pay. Second, firms entering into such commitments engage in earnings management to meet the promised performance target when actual performance falls short, and firms facing greater default costs tend to manage earnings more aggressively. Third, depending on the performance metric stipulated in the commitment contract, firms employ varying methods to manage earnings. We also find that firms that rely on earnings management to meet their performance targets display inferior performance in the postcommitment years relative to firms that do not. Overall, our evidence is consistent with performance commitment contracts (with costly defaults) between a firm's controlling and minority shareholders causing incentives for earnings management.

This paper examines whether and how individual auditors are disciplined for audit errors. Taking advantage of the long history of auditor identity data from China, we find that signing auditors with client restatements are likely to lose the privilege of signing the audit reports of public clients. However, auditors can avoid this consequence by issuing a modified audit opinion to warn of the potential misstatement. We show that auditors are more likely to be disciplined when their firms operate in less concentrated audit markets. Finally, we find positive outcomes from the disciplinary action of the audit firms. Firms that discipline their auditors for restatements have a larger decrease in the rate of client restatements and a larger increase in market share, compared to nondisciplining firms. Their clients have a higher earnings response coefficient after the disciplinary action. In summary, our results suggest that individual auditors in China can face career setbacks when they produce poor quality audits.