Conservative Accounting, IFRS Convergence and Cash Dividend Payments: Evidence from China

Date01 June 2017
Published date01 June 2017
Conservative Accounting, IFRS
Convergence and Cash Dividend
Payments: Evidence from
William Bradford
Foster School of Business, University of Washington, Seattle, Washington 98195-3226 USA; and
Faculty Fellow, China Academy of Financial Research, Shanghai, China
Chao Chen
School of Management, Fudan University, 670 Guoshun Road, Siyuan Building #314, Shanghai, China
Song Zhu
Business School, Beijing Normal University, 19# Xinjiekouwai Street, Beijing, China 100875
We investigate the governance role of conservative accounting in mitigating the
creditorstockholder conict by affecting rmsdividend policies, and how
the convergence to International Financial Reporting Standards (IFRS) affects the
governance role of conservative accounting as it relates to dividend policy. We
analyze data on Chinese listed rms from 2000 through 2011. The use of
conservative accounting reduced cash dividend payouts, thereby playing a
governance role by mitigating the rms creditorstockholder agency conict.
However, Chinas convergence to IFRS reduced the governance role of
conservative accounting on dividend policy by reducing the accounting
conservatism of listed rms in China.
Keywords: accounting conservatism, mandatory IFRS adoption, cash dividend
JEL classification: G32,G35,G38
The authors thank Terry Shevlin, Lloyd Tanlu and two anonymous referees for helpful comments
on earlier versions of this paper. We acknowledge the support of the National Natural Science
Foundation of China (Chao Chen, Project No. 71472048 and Song Zhu, Grant No. 71302023).
European Financial Management, Vol. 23, No. 3, 2017, 376414
doi: 10.1111/eufm.12114
© 2017 John Wiley & Sons, Ltd.
1. Introduction
Accounting Conservatism, an important aspect of the quality of accounting information,
affects the information asymmetry between stakeholders (LaFond and Roychowdhury,
2008; LaFond and Watts, 2008) and related agency problems (Watts, 2003), thus
signicantly inuencing the efciency of a rmsnancing and investing activities
(Biddle and Hilary, 2006; Liang and Wen, 2007; Zhang, 2008b; Garc
ıa Lara et al., 2011).
Scholars have investigated the governance role of accounting conservatism in reducing
agency costs between creditors and shareholders in cash dividend payouts and found that
in Western countries, accounting conservatism can effectively reduce the cash payment
to shareholders (Zhang, 2008b; Louis and Urcan, 2015).
We use rms listed on Chinese stock exchanges to explore the relationship between a
rms cash dividend policy and its use of accounting conservatism. On 1 January 2007,
China adopted a new set of Chinese accounting standards (CAS) that substantially
converge with the International Financial Reporting Standards (IFRS; Deloitte Touche
Tohmatsu, 2006; DeFond et al., 2011; Ke et al., 2012).
This study also investigates how
the IFRS affect the information quality and, thereafter, cash dividend payments of rms
that are listed on Chinese stock exchanges.
Since China is the worlds largest developing economy and the second largest
economy overall, there is justiable interest in the dividend policy of Chinese listed
rms. More importantly, Chinas unique institutional setting provides a rich backdrop to
examine how conservative accounting under domestic and international accounting
standards affects rmsnancial decisions. Dividend policy is a major nancial decision
of Chinas publicly listed rms because, among other reasons, from 1999 through 2012,
nearly half of the total return of the MSCI China Index came from dividends paid to
stockholders (Levisohn, 2013).
The institutional setting in China is different from that in the US and other developed
countries, and we highlight four institutional traits that distinguish China. First, publicly
traded rms in China include state-owned rms (SOEs). It is important to understand
how government ownership affects the use and efcacy of accounting conservatism and
rmsdividend policies. This study compares the differences in accounting conservatism
between SOEs and non-state-owned enterprises (NSOEs), the differences between SOEs
and NSOEs on the impact of accounting conservatism on dividend policy, and how these
relationships changed after Chinas convergence to IFRS.
Second, China is considered to have a weak judicial system as it relates to business
transactions, but its judicial system has been developing along with its economy. In
countries with strong judicial systems, accounting reports are more conservative; rms in
these countries tend to reect bad news in earnings more quickly than rms in countries
with weak judicial systems (Ball et al., 2000; Ball et al., 2003; Holthausen, 2003;
Bushman and Piotroski, 2006). However, Xia and Zhu (2009) show that with the
Deloitte Touche Tohmatsu (2006) provides a detailed comparison of the old Chinese GAAP
and the IFRS standards that were adopted. In this publication, Sir David Tweedie, then
Chairman of the International Accounting Standards Boards states (p.1): The adoption of the
new Chinese accounting standards system brings about substantial convergence between
Chinese standards and International Financial Reporting Standards (IFRSs), as set by the
International Accounting Standards Board (IASB).
© 2017 John Wiley & Sons, Ltd.
Conservative Accounting, IFRS Convergence and Cash Dividend Payments 377
implementation of more conservative accounting standards and the enforcement of
regulations, the nancial reporting of rms in China has been more conservative since
2001. In addition, Chen et al. (2010) provide evidence that Chinas legal system enforces
debt provisions and debt covenants of listed rms in China including restrictions that
limit dividends.
With regard to the effect of IFRS on accounting quality, Ahmed et al. (2013) who did
not include China in their study conclude that the convergence to IFRS does not affect
accounting quality in weak enforcement countries. We note that judiciary systems are
multifaceted and the weaknessof laws and law enforcement can vary across the
business spectrum, thus affecting some decisions less than others. Our study considers
how, in Chinas transitioning weak judicial system setting, accounting conservatism
impacts dividend policy and how that impact has changed after the adoption of the IFRS.
Third, until 2004, government entities in China that owned common stock of listed
rms could not easily sell their shares at the current market price. A dominant method for
getting cash from holding shares was through the rm paying dividends. Subsequent to
2004, the shares held by government entities became saleable (via the Chinese
governmentssplit share structure reform), and thus the pressure on SOEs to pay
dividends was reduced. We include controls for the pre- and post-split share structure
reform periods and thus explore the role of accounting conservatism on dividend policy
both before and after the split share structure reform in China.
Fourth, unlike the US, in China, both the government and private investors control a
large number of listed rms through pyramid structures (Fan et al., 2005; Zhu, 2006).
Corporate ownership through pyramid structures is popular around the world (the US
and UK excluded) due to the private benets of control rights (Attig et al., 2003).
Pyramid structure ownership is more prevalent in countries and regions with weaker
laws and undeveloped economies (La Porta et al., 1999; Claessens et al., 2000). Ultimate
owners (those at the apex) of the pyramid can control multiple resources relative to their
investment through a corporate pyramid structure. We explore how the ownership of the
ultimate shareholder affects the conservatism of rmsaccounting before and after the
adoption of IFRS in China. We also examine how ultimate shareholder ownership
interacts with conservative accounting to affect the dividend payout of rms in China.
The determinants of rmsdividend policies have long been the source of interest and
inquiry for business scholars (Lintner, 1956; Miller and Modigliani, 1961; Black, 1976).
Agency theory suggests that dividend policy affects the stockholdercreditor conict
because paying cash dividends to stockholders reduces the funds available to pay
creditorsclaims (Jensen and Meckling, 1976). Overpayment of cash dividends to
shareholders will damage the interests of creditors and may lead to the inefciency of
debt contracts. Accounting scholars propose that conservatism can enhance the
efciency of debt contracting (Watts and Zimmerman, 1986; Watts, 2003) and protect
creditors because conservative accounting dampens the reported net income and retained
earnings, which can reduce cash dividends (Watts and Zimmerman, 1986). There is,
however, little evidence on the debt-contracting benets of conservatism (Ahmed et al.,
2002; Moerman, 2008; Zhang, 2008b; Nikolaev, 2010), and even less research in
emerging markets with weak investor protections on whether conservative accounting
can mitigate the creditorstockholder agency conict by reducing cash dividends
(Frankel et al., 2008).
The accounting literature devoted to assessing the consequences of mandatory IFRS
adoption around the world is abundant and growing, but the related research is
© 2017 John Wiley & Sons, Ltd.
378 William Bradford, Chao Chen and Song Zhu

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