Industry classification
China’s impressive economic growth has not only lifted hundreds of millions of people out of poverty but also increased the importance of China’s role in the global economy. One of the main contributions of China to the global economy stems from its status as the manufacturing centre of the world.4 The manufacturing sector accounts for nearly one-third of China’s GDP and around 50% of the market capitalization of the Chinese stock market, which makes China more specialized in manufacturing than most other emerging economies (Hanson and Robertson 2008). As manufacturing is the dominant sector in China, the competition among manufacturing firms for equity capital is expected to be greater than in other sectors. Thus, it is also expected that IFRS convergence will have more impact on Chinese manufacturing firms than on their counterparts in other sectors.
Regional development
Despite China’s impressive growth, significant differences in the level of economic development exist across regions. The development of coastal regions has been prioritized by China’s economic reform policies and stimulated by the demand for international trade. The gap between economic activities in coastal regions and those in inland provinces influences institutional developments such as financial markets and government decentralization, as well as the legal environment. These factors are known to influence the financial reporting incentives of firms (eg Leuz et al. 2003). Indeed, empirical evidence suggests that these institutional development differences even influence the choice of auditors by Chinese firms (Wang et al. 2008). Thus, institutional differences across regions within China are also expected to affect the impact of IFRS convergence.
State control
In spite of the general trend towards a free market economy, the Chinese government still maintains substantial ownership of and control over a majority of Chinese listed firms. This approach differs from other ex-communist transitional economies (such as Russia) where the governments have largely relinquished their ownership of listed firms. At present, nearly two-thirds of firms listed on stock exchanges in mainland China still have either central or local government-affiliated controlling shareholders. The government also influences the executive appointments of firms under its control. In return, the government provides benefits such as business contracts and financial support of various kinds. Thus, state-controlled firms are generally expected to serve the government’s political and social objectives (eg Bai et al. 2000; Szamosszegi and Kyle 2011) more than the demands of outside investors in the capital market. As a result, the impact of IFRS convergence on such state-controlled firms, especially on those under the central government, is expected to be smaller than on those outside state control.
Foreign ownership
Owing to their information disadvantage, foreign investors usually have a greater demand for corporate transparency than domestic investors (Leuz et al. 2010). The lack of local knowledge about the institutional background and business culture in China also increases foreign investors’ reliance on hard information from financial statements. As a result of this, the increase of financial statement comparability or accounting disclosure quality after IFRS convergence is expected to benefit foreign investors more than their domestic counterparts. This view is supported by the study of Tan et al. (2011), which shows a greater increase in forecast accuracy after mandatory IFRS adoption, and a greater increase in following by foreign analysts than by domestic ones. To the extent that Chinese firms’ financial reporting caters for the information demands of foreign investors, the benefit of IFRS convergence would be expected to be more pronounced in firms with foreign ownership.
Delisting regulation
To benefit economic development and ensure that equity capital is largely directed to firms with good performance, the regulator of the Chinese stock market mandates that listed firms that report two years of consecutive losses be classified as specially treated (ST) firms. Firms classified as ST are associated with various trading and financial restrictions. For example, unlike other firms, they will have the trading of their stock suspended if their daily price volatility exceeds 5%. Moreover, ST firms cannot raise additional capital from the stock market. If the firm reports one more year of loss, it will be suspended from trading on the stock exchanges. Finally, such firms will be fully delisted if they suffer a fourth consecutive year of loss. This delisting rule increases the incentives of firms with weak performance to engage in earnings management to avoid delisting (Jiang and Wang 2008). As a set of principles-based accounting standards, IFRS provides firms with more financial reporting discretion. Thus, it is possible that firms that are concerned about potential delisting may take advantage of the flexibility afforded by IFRS-converged CAS to avoid reporting multiple losses. For such firms, earnings quality may decline following IFRS convergence.
State subsidy
Although the Chinese form of capitalism is becoming increasingly more market-oriented and less centrally planned, the government continues to influence economic development through the provision of subsidies. Allen et al. (2005) show that government subsidy is one of the four most important sources of finance for all Chinese firms. Subsidies are often provided to facilitate the development of sectors prioritized by the government, such as energy, aerospace/defence, transportation and high-tech industries (Chen et al. 2008). Firms that receive subsidies from the government are expected to have fewer financial constraints and to be less likely to rely on outside capital markets to supply their financial needs. Thus, the benefit of IFRS convergence is expected to be greater for firms that receive lower government subsidies because such firms have greater reliance on equity investors.
