Regulatory Incentives for Earnings Management through Asset Impairment Reversals in China

While asset impairment reversals are practiced in many jurisdictions, empirical evidence is rare. China provides us with a unique opportunity to examine both the determinants and consequences of impairment reversals resulting from recent developments in standard-setting and its specific performance-based listing requirements. Based on a sample of reversal firms in China, we report the following findings: First, Chinese-listed companies are motivated by regulatory incentives to reverse asset impairments to reduce or avoid the possibility of trading suspension or de-listing. Second, we provide some evidence that the value-relevance of reversal information appears to be negatively affected by the regulatory-motivated earnings management. Third, favorable internal and external monitoring mechanisms play a role in constraining this type of earnings management. Taken together, we conclude that while the intention of granting reversal discretion is for managers to reveal private value recovery information, our findings suggest that a seemingly improved accounting standard does not necessarily lead to its intended consequence in financial reporting.

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