Trade-off between real activities earnings management and accrual-based manipulation-evidence from China

This study investigates the trade-off between real activities earnings management and accrual-based earnings management of Chinese listed companies. We first establish a model in which the manager could choose between accrual-based or real activities earnings management, and solve for the optimal level of each kind of earnings management. Based on the results of the theoretical model, we empirically investigate how managers choose between the two kinds of earnings management. Our empirical tests use China's institutional background with data of listed companies from 2008 to 2012. Results indicate that the level of real activities earnings management is higher for firms under lower government intervention, firms with higher financial leverage and lower corporate governance. Firms in a less stringent legal environment, double-listed firms and firms with higher growth prospects are more likely to engage in accrual-based earnings management. The results provide implications about the accounting choice of listed companies under China's unique institutional characteristics.