Short Communication
Corporate site visits and earnings management

https://doi.org/10.1016/j.jaccpubpol.2021.106823Get rights and content

Highlights

  • Analysis of association between earnings management (EM) and corporate site visits.

  • Negative association exists between accrual-based EM and the number of site visits.

  • Accrual-based EM and number of institutional investors negatively associated.

  • Accrual-based EM and depth and breadth of communication negatively associated.

Abstract

This study conducts the first analysis of the association between earnings management (EM) and corporate site visits. Results show that a corporate’s accrual-based EM is negatively associated with investors’ site visits, the number of external participants, especially institutional investors, and the depth and breadth of communication during a site visit. However, no significant relationship is found between the presence of core managers, non-institutional investors and accrual-based EM. Our findings provide significant implications for investors and regulators who seek to constrain EM.

Introduction

Private communication has long served as the most important informal interaction channel between investors and corporate insiders (Bushee et al., 2018, Bowen et al., 2018, Cheng et al., 2016). Prior research (mainly case studies) infers that activist investors rely on private communication to influence firms’ behaviors (Gillian et al., 1998, Parrino et al., 2003). However, empirical studies that directly investigate the relationship between private communication and firms’ behaviors are hampered by data limitations (Green et al., 2014, Chen et al., 2020). For example, in the U.S. and Europe, companies either do not maintain archival records of private communications, or prohibit the distribution of such information (Cheng et al., 2016). By applying the unique dataset of China’s Shenzhen Stock market, this study fills the void by investigating the relationship between listed companies’ earnings management (EM) and a specific type of private communication: corporate site visits.

This study contributes to previous literature in several ways. First, the study adds to our understanding of site visits, or more generally, private communication. Site visit constitute the most important and most popular form of private communication due to their effectiveness (Cheng et al., 2016, Chen et al., 2020). Compared with other forms of private communication1, site visits allow visitors to not only observe firms’ facilities and operation process and further gain earnings-related information and other soft information, but also interact directly with corporate insiders and exert pressure on executives by questioning them and expressing concerns (Cheng et al., 2016, Chen et al., 2020).

After Shenzhen Stock market’s recent requirement to disclose information about corporate site visits, there has been a rapid increase in the number of studies on site visits (Bowen et al., 2018, Cheng et al., 2016, Cheng et al., 2018, Green et al., 2014, Liu et al., 2017, Kirk and Markov, 2016). These studies mainly focus on the information content or the market reaction after these visits (Chen et al., 2020). For example, Cheng et al. (2016) found that analysts who conduct site visits exhibit greater forecast accuracy than those who do not. Bowen et al. (2018) found that corporate insiders conduct a majority of their stock sales based on these site visits and reap financial gains through this type of informed trading. Cheng et al. (2018) found that around the time when site visits are conducted, stock returns are positively associated with forthcoming earnings news.

Apart from studies that focus on information content or market reactions related to private communication, there is also literature which infers that through private communication, investors can influence firms’ behaviors; however, these studies only use case studies or very small samples (Gillian et al., 1998, Parrino et al., 2003, Chen et al., 2020). This study tries to extend the empirical research of private communication and its impact by focusing on the relationship between site visits and EM.

This study also contributes to the literature regarding analysts/blockholders and financial reporting quality. Previous literature documents that communicating with companies directly is the main way for analysts or blockholders to acquire firms’ information (Lang and Lundholm, 1996, Chen et al., 2007, Chen et al., 2010). In this process, analysts/blockholders also possibly influence companies’ financial reporting quality (Dou et al., 2016, Hope et al., 2013, Jiang, 2008). However, direct investigation into the communication channels that connect analysts/blockholders and corporates, is still lacking due to data limitations. That is, we need to further investigate through what specific channel analysts/blockholders interact with firms, and how the interaction mechanism works.

To fill this gap, we focus on site visits as the main channel connecting analysts/investors and a corporate entity; more importantly, by considering the detailed characteristics of site visits, including the depth and breadth of communication and the presence of core managers, this study tries to open the black box of private communication to reveal how analysts/blockholders interact with corporate insiders and their corresponding influence.

Section snippets

Data

Our study used unique data from corporate site visits, available on the Shenzhen Stock Exchange (SZSE)2. In 2012, the SZSE issued regulations that require firms to publish, on the stock exchange’s web portal, a standard summary report with detailed information on each site visit. We manually

Baseline results

Baseline results are presented in Table 2. In regression (1) of Table 2, the estimate of the coefficient of the key independent variable Visits is negative and significant at the 5% level; in regression (2), for the coefficient estimate of the variable Total_participant, the total number of external participants is negative and significant; thus, indicating the negative association between accrual-based EM and the number of site visits or external participants.

In regressions 3 and 4 of Table 2,

Conclusion

This study was the first to examine the relationship between site visits and EM. The empirical results show that a corporate’s accrual-based EM is negatively associated with site visits, the number of external participants, especially institutional investors, and the depth and breadth of communication during a site visit. The IV approach is applied to mitigate the potential endogeneity arising from reverse causality. We interpret the results mainly from the perspective of the role of the site

Funding

This work was supported by The Humanities and Social Science Research Project of the Ministry of Education of China [Grant number 18YJC790126& 19YJCGJW009]; Guangdong Natural Science Foundation [Grant number 2018A0303070011& 2018A030310149]

Declaration of Competing Interest

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

Zhen QI, Ph.D., is an Associate Professor at the School of Economics and Statistics, Guangzhou University. Dr. Qi earned his doctorate from the Graduate School of Chinese Academy of Social Sciences in 2016. Zhen QI conducts research in various areas, including international economics and corporate governance.

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    Zhen QI, Ph.D., is an Associate Professor at the School of Economics and Statistics, Guangzhou University. Dr. Qi earned his doctorate from the Graduate School of Chinese Academy of Social Sciences in 2016. Zhen QI conducts research in various areas, including international economics and corporate governance.

    Jian CHEN, Ph.D., is a researcher fellow at the School of Economics and Statistics, Guangzhou University. Dr. Chen earned his doctorate from the Graduate School of Chinese Academy of Social Sciences in 2017. He is also an Executive Director at CITIC Capital. He conducts research mainly in corporate finance.

    Yixiao ZHOU, Ph.D., is a Senior Lecturer of Economics at Crawford School of Public Policy, The Australian National University. Dr. Zhou earned her doctorate from The Australian National University in 2014. Her research encompasses a range of topics in public policy analysis and management, economic and finance.

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