Economic policy uncertainty and earnings management: evidence from China

This study investigates the effects of economic policy uncertainty (EPU) on earnings management (EM) practices in Chinese firms. One line of research suggests that managers are likely to improve the financial reporting quality, while another line of research indicates that managers may degrade the reporting quality by increasing EM when EPU increases. We argue that one of the causes of these conflicting results is that extant literature has not fully considered the institutional features of each country. We posit that the underdeveloped institutional environment and less efficient information system in Chinese capital market encourage managers to engage in more EM. The findings showed that Chinese firms were more likely to manipulate earnings using both accrual-based earnings management (AM) and real activity-based earnings management (RM) when EPU rises. They also tend to respond heterogeneously to the changes in EPU depending on their ownership and industry types.