In January 1996, China Securities Regulatory Commission (CSRC) issued a guideline that requires listed firms to have return on equity of at least 10 percent in each of the preceding three years in order to qualify for a rights offering. This reliance on accounting numbers by standard setters provides managers with incentives to manipulate earnings to meet the target ROE. This paper investigates whether Chinese companies listed on the Shanghai and Shenzhen Stock Exchanges manipulated their earnings in response to the CSRC's guideline of rights offering. I examine the frequency distribution of firms' ROE around the issuance of the CSRC's guideline, and find that after the issuance of the guideline a considerable large number of firms reported ROE of slightly above 10 percent, and both the...[ Read more ]

In January 1996, China Securities Regulatory Commission (CSRC) issued a guideline that requires listed firms to have return on equity of at least 10 percent in each of the preceding three years in order to qualify for a rights offering. This reliance on accounting numbers by standard setters provides managers with incentives to manipulate earnings to meet the target ROE. This paper investigates whether Chinese companies listed on the Shanghai and Shenzhen Stock Exchanges manipulated their earnings in response to the CSRC's guideline of rights offering. I examine the frequency distribution of firms' ROE around the issuance of the CSRC's guideline, and find that after the issuance of the guideline a considerable large number of firms reported ROE of slightly above 10 percent, and both the companies with very high earnings and companies with very low earnings might have reduced current earnings to save for the future. Since firms with a low current ratio demand more cash to improve liquidity and therefore, are expected to have higher incentive to manage their earnings, I further partition the sample into four groups based on the level of current ratio. I find that the ROE distribution for firms with a low current ratio shows more significant concentration in the l0%-12% interval. Finally I also find the ROE distribution for the rights-offering firms concentrates more significantly in the l0%-12% interval than does the ROE distribution for the non-rights-offering frrrns. These results further support earnings management hypothesis.