1 Introduction

Financial accounting information is the resulting product of internal accounting and external reporting systems which measure and disclose fundamental information regarding financial situation and the operating performance of the firm（Bushman and Smith, 2001）. To guarantee the efficient allocation and utilization of capital resources, it is essential that financial accounting information including earnings information is measured and reported in a true and fair manner so as to facilitate corporate stakeholders′ decision-making processes. However, corporate earnings management activities are increasingly and globally widespread, thereby drawing considerable attention from regulators, practitioners and the mass media especially after the recent accounting scandals involving giant companies such as Enron, WorldCom and Xerox. On September 1998, Arthur Levitt, chairman of the Security Exchange Commission（SEC）, spoke to CPAs, lawyers and academics about“The Numbers Game”, committing the SEC in no uncertain terms to a serious, highpriority attack on earnings management. Loomis（1999）also argues there are“great expanses of accounting rot, just waiting to be revealed.”Therefore, it is crucial to investigate corporate earnings management behaviors and the factors that can explain the variances of earnings management among companies.

Following Healy and Wahlen（1999）, we define earnings management as the alteration of firms′earnings information“to either mislead some stakeholders about the underlying economic performance of the company,or to influence contractual outcomes that depend on reported accounting numbers.”

1.1 Motivations of corporate earnings management

According to previous studies（Fan and Wong, 2002; Leuz et al., 2003;Gopalan and Jayaraman,2012）,corporate ownership structure and associated agency problems can shape earnings management due to the conflicts of interest between the principle and agent.Firms also manage reported earnings with the intention to decrease the possibility of political scrutiny or to limit the firm-specific information leakage to potential competitors.

1.1.1 Agency problems and earnings management

Agency problems,arising from the separation of ownership and control, are the essential element of the contractual view of modern corporations（Jensen and Meckling,1976; Fama and Jensen, 1983a, 1983b）. The magnitude of ownership concentration determines the nature of agency problems（Fan and Wong,2002）.

（1）Type I agency problem

Based on the notion of Berle and Means（1932）, ownership is widely dispersed among shareholders,while control is concentrated in the hand of managers who own an insignificant amount of equity. This scenario is mostly typical for U.S. and U.K. companies. Agency problem encountered under such circumstance（Type I）derives from the conflicts of interest between shareholders and managers（Jensen and Meckling,1976;Grossman and Hart,1988）. In such,managers can be motivated to act out of their self-interest（e.g.,perquisite consumption or empire building）rather than out of the goal of maximization of shareholders′ value. Performance-based compensation packages, including performance-based bonus and salary revision, performance-based dismissal decision and stock option, can help alleviate deviating managerial behaviors（Jensen and Meckling, 1976; Haugen and Senbet, 1981;Jensen and Murphy, 1990; Mehran, 1995）. However, it is commonly believed that these compensation schemes inevitably motivate managers to manipulate reported earnings in order to increase their wealth（Healy,1985;Cheng and Warfield,2005;Goldman and Slezak, 2006; Bergstresser and Philippon, 2006; Burns and Kedia, 2006）.

（2）Type II agency problem

Compared to the notion by Berle and Means（1932）of a widely held corporation, recent research shows that ownership is concentrated to the degree that one owner has effective control rights over the firm.This is the case especially in many developed and developing countries outside the U.S. and U.K., such as continental European and East Asian countries（Demsetz, 1983; Shleifer and Vishny, 1986; Holderness and Sheehan,1988;La Porta et al.,1998;La Porta et al.,1999）. Accordingly,agency problem that arises as consequences of these circumstances（Type II）derives from the conflicts of interest between controlling shareholders（also called insiders）and minority shareholders.

Possessing effective control over the firm can entrench controlling shareholders in circumstances of being increasingly released from governance by board of directors and from disciplinary mechanisms inherent in external market for corporate control（Shleifer and Vishny,1997;La Porta et al.,1999; Johnson et al., 2000; Fan and Wong, 2002; Liu and Lu, 2007）. Meanwhile, a series of means, including pyramids, cross-holding shares and dual-class shares are adopted by insiders to enhance their control over the firm, and thereby, induce the divergence between voting（control）rights and cash flow（ownership）rights. Such control divergence exacerbates the entrenchment problem,since it enables insiders to control the process of a firm′s decision-making, even when their ownership is relatively small. As a result, insiders are incentivized to exclusively extract and enjoy private benefits of control at the expense of minority shareholders′wealth（Claessens et al.,2002;Lins, 2003;Denis and McConnell, 2003; Leuz et al., 2003）. Since financial statements potentially provide outside minority shareholders with information regarding the fundamental performance of reported firms, minority shareholders can detect the expropriation of insiders through analysis of financial reports. If extraction of these private benefits is detected, outside intervention and heavy penalty would be imposed on insiders. Therefore, insiders have incentive to conceal their value-decreasing behaviors by managing reported earnings（Kim and Yi,2006; Leuz et al.,2003; Fan and Wong,2002）. For instance, insiders can use accounting discretion to overstate earnings and conceal poor performance due to the expropriation. In well-performing years, insiders can also exert reporting discretion to understate earnings and create reserves for the future. In either case, insiders are capable of concealing their evidence of expropriation by manipulating the level and variability of reported earnings.

（3）Agency problem of debt

It is well-documented that firms commonly rely on debt financing as the most important source of external financing.Creditors who have prior fixed claims on a firm′s cash flow face conflicts of interest with shareholders who retain the residual claims. Specifically,shareholders have an incentive to substitute firms′ low-risk assets by undertaking high-risk investments with high returns（Jensen and Meckling,1976）.In this situation, debt-holders bear the increased risk of such assets substitution;whereas, shareholders would benefit due to added values of risky projects. Alternatively,the agency problem of debt can take a form in which shareholders lose incentive to invest in new projects with positive NPV if remaining debt payments are much higher than future profitability（Myers, 1977）. The reason of such underinvestment is that shareholders bear the costs of new investments but only possess a limited portion of future benefits. In order to compensate the adverse consequence due to these deviating incentives for shareholders, creditors will likely claim high interest rates and thereby increase the costs of debt. In such, debt covenant is a mechanism through which shareholders can mitigate agency costs of debt. Given that debt covenant is partially designed based on accounting measures,firms are motivated to engage in earnings management to improve their financing conditions or to avoid the violations of debt covenants（Zmijewski and Hagerman,1981）.

1.1.2 Other motivations of earnings management

（1）Political cost incentives for earnings management

Firms have incentives to engage in earnings management to avoid or reduce the political costs involved that refer to the potential wealth transfers associated with political scrutiny（such as antitrust investigations）. Accounting information plays an essential role in the political process. For instance,the Department of Justice and the Federal Trade Commission,two agencies in charge of the enforcement of U.S.antitrust law,view accounting profits as an indicator of potential monopolies and rely on these measures of accounting profitability in prosecuting antitrust violations. Therefore, managers in firms that are likely subject to political scrutiny are motivated to adopt income-decreasing accounting procedures in order to report low levels of profits, and further,to evade unwanted political interventions and costs（Watts and Zimmerman, 1978;Cahan,1992;Key,1997）.

（2）Information argument of earnings management

In competitive markets, firms possessing proprietary information（e.g., superior and profitable technologies,innovations or patents）are likely imitated by rivals, and thus, potentially incur the spillover of this firm-specific proprietary information（Mansfield, 1985）. Undoubtedly, precise financial disclosure increases the possibility of such information spillover. For example, increased accounting profitability provides channels through which competitors can learn about the viability of a firm′s ongoing projects. Therefore, accounting opacity that makes it difficult for competitors to detect a firm′s proprietary situation is an effective strategy to prevent the leakage of proprietary information to competitors（Fan and Wong, 2002; Fan et al.,2013）. Consistent with this argument, Fan et al.（2013）find that accounting transparency is relatively low for Chinese firms located in regions in which there is great threat of proprietary information leakage.