The Association between Earnings Persistence and Internal Control Quality: Evidence from China

Abstract

We investigated the association between internal control quality (ICQ) and earnings persistence (EP) in the Chinese capital market. Specifically, we examined how ICQ exerts an influence on EP, using data from listed A-share corporations in the Shanghai Stock Exchange and the Shenzhen Stock Exchange, from 2008 to 2011. We assumed that a more favorable internal control environment could prevent managers and employees from exploiting company resources or embezzling company property, preventing managers from using opportunistic earnings management (accrual-based or real earnings management) and motivating them to strive for the corporation. The company would thus be more likely to operate efficiently and effectively, resulting in higher EP. Consistent with this assumption, our findings suggest that firms with better ICQ have less real activities manipulation, and that a lesser extent of real earnings management results in higher EP.