Using data from 123 reverse mergers (RMs) in China, this study investigates the determinants and economic consequences of auditor choice in RMs. We find that the choice of a new auditor instead of the incumbent auditor is not related to auditor competence but to the relative bargaining power of RM firms and publicly listed firms (shell firms), and that the probability of choosing new auditors is higher when RM firms have more bargaining power relative to shell firms. We also find that hiring new auditors in the RM is associated with a higher valuation of injected assets and higher pre-listing income-increasing discretionary accruals in RM firms. Furthermore, post-merger firms exhibit drops in accounting performance and firm value and are more likely to restate their financial reports within 3 years of listing when new auditors are appointed in RMs. Finally, the cross-sectional test shows that this effect mainly exists in the context of RMs where the newly appointed auditor is a non-Big 10 auditor and a non-specialist auditor. Overall, our results emphasize the role of RM firms and shell firms in auditor choice for RMs and highlight the implications of such a joint decision on investor protection.

We examine the effects of the world’s first comply-or-explain dividend regulation in China’s Shanghai Stock Exchange, which requires firms to either pay at least 30% of profits as dividends or explain the use of funds. We find that many firms increased their payout ratio to comply, by increasing dividends or decreasing earnings. Firms with high profitability, state ownership, and fewer agency conflicts were more likely to comply. However, complying firms subsequently issued more debt and had a decline in accounting performance and firm valuation. The evidence suggests that the comply-or-explain regulation increased firms’ dividends at substantial costs.

Business groups organized by pyramids enable the ultimate shareholders to control a portfolio of firms with less cash requirement. Further, corporate pyramid induces an internal capital market and makes capital transfer more convenient within the pyramid. In China, the state and business groups control a large number of listed firms through pyramidal ownership structure. What role does the corporate pyramid play in firms’ investment decisions? What is its influence on firm performance? This paper investigates the capital investment and firm performance from the perspective of pyramidal ownership structure. We find that as the layers of corporate pyramid increases, the capital overinvestment declines. The negative relations between pyramid and overinvestment exist for both state-owned enterprises (SOEs) and non-state-owned enterprises (NSOEs), which indicate that increasing the layers within corporate pyramid reduces the likelihood of overinvestment of the listing firm and improving investment efficiency. Moreover, we show that the effects of increasing the layers of corporate pyramid on accounting performance are different for SOEs and NSOES. For SOEs, increasing the layers of pyramid results in less government interference on the listed firm and more flexibility in operate. Therefore, increasing pyramidal layers is positively related to accounting performance. While for NSOEs, pyramiding is to build an internal capital market for the ultimate shareholder’s capital investment. Although pyramid may reduce overinvestment of the listing firm, agency costs may offset the positive effect and induce a lower accounting performance.

Using a sample of listed subsidiaries and their parent companies in China, I study top executive compensation and turnover and their relationship to firm performance in business groups in China. The empirical results support the hypothesis that the pay-performance sensitivity of managerial compensation (CEO turnover) in a listed firm is positively (negatively) related to the accounting performance of its parent company. Using related party transactions to proxy for the correlation between the two firms, I find that management compensation in a listed firm is related to the performance of its parent company if related party transactions exist between them. In addition, I find a stronger relationship between the compensation (turnover) in a listed subsidiary and the performance of its parent company when the percentage of common directors and managers are less than median level. This result indicates that the incentive system can be used to align the interests of managers in the listed firm with that of its parent company when the information asymmetry is high and the parent company can not effectively monitor. Using brand name as a proxy for reputation, I find that management compensation and CEO turnover in group firms are more likely to be sensitive to the performance measures in their parent companies if both use the same brand name.

This paper investigates control mechanism and accounting information used for control mechanism, shaped by government incentives for business. Using a sample of China's state-owned enterprises (SOEs) from 2001 to 2005, it finds that the likelihood of top management turnover in China's SOEs, which is an important aspect of corporate control mechanism, is inversely associated with two types of accounting information of firm performance, firm-specific accounting performance and relative accounting performance, which is induced by the interests of Chinese government for the economic performance and political competition. Further, this paper finds that relative accounting performance, especially regional relative accounting performance, receives more weight in turnover decisions if a SOE is a local monopolistic firm or in local monopoly, because relative performance measure could offer a relatively simple benchmark for local government to assess manager's quality and provide stronger incentive scheme in China's political environment. By seeking deeper understanding into government incentives, the findings imply that induced by government incentives, effective corporate governance which is based on distinguished characteristics of accounting information exists in an economy highly involved by government.

This paper hypothesizes that the threat of losing listing status in China’s distressed ST (specialtreatment) firms kick starts a corporate control market that does not exist otherwise. The incumbent controlling shareholder, facing the possibility of losing control right, will have to“tunnel back” the value he has extracted from the firm before to boost the distressed firm’s accounting performance. This part of value is captured by the cumulative abnormal returns (CARs) surrounding ST event. We further argue that ST CARs present themselves as alternative measure of private benefits of control, distinguished from the ones used in Barclay and Holderness (1989) and Nenova (2000). Studying 66 listing companies that had become ST between 1998 and 2000 in China’s stock market, we find that the 22-month cumulative abnormal returns run as high as 29% on average. Based on a game theoretic model, we find that the control value released through the contest for corporate control right is positively related the largest shareholder’s shareholding, concentration of shares held by other largest shareholders, but negatively correlated with the firm’s leverage ratio. Our empirical evidence confirms these hypotheses.

We investigate how the market for corporate control (external governance) and shareholder activism (internal governance) interact. Looking at equity prices from 1990 to 2001, we find that these mechanisms are strong complements. A portfolio that buys firms with the highest level of takeover vulnerability and shorts firms with the lowest level of takeover vulnerability generates an annualized abnormal return of 10 - 15% only when public pension fund (blockholder) ownership is high as well. A similar portfolio created to mimic the importance of internal governance generates annualized abnormal returns of 8%, though only in the presence of ‘high’ vulnerability to takeovers. Further, we show that the complementary relation exists for firms with lower industry-adjusted leverage and is stronger for smaller firms. The complementary relation is confirmed using accounting measures of profitability. Using data on acquisitions, firm level Q’s and accounting performance, we explore possible interpretations, providing preliminary evidence for a risk effect as well.