Reasons behind presumed low financial reporting quality (FRQ) in China

Abstract: China and its economic development is today something that affects us all in one way or another. Through economic expansion Chinese companies starts to be an important player on the global scene. They are getting an international competitor, co-operating with foreign companies and it has the latest year been heavily invested in by foreign financiers. Conversely, according to recent research a vast majority of the experts claims that the Chinese companies’ financial reporting disclosure holds a low quality. That these financial reports include plentiful falsified information is disturbing the market and prevents shareholders a fair and free view of the companies, it also reduces the control possibilities. Voices have been raised demanding changes to ensure a higher FRQ in the future. But to find the right actions and point out needed changes, the first requirement is finding the roots behind the presumed low FRQ. Experts’ point at different directions, comprising of nine main underlying reasons that are primarily considered affecting the FRQ in negative matters. These nine explanations will be evaluated against each other in this thesis to find out where the main focus needs to be to prevent future falsified financial statements. The nine reasons where it is claimed that China are lacking are: - Legal system -Education -Pressure -Political impact -Ownership structure -Auditing -Low Business ethics -Tax avoidance -Cost reduction This thesis finds that the main underlying reasons behind Chinese firms’ falsified financial stamen are: (1) Pressure – that influences managers and is a great incentive for earnings management. (2) Political impact – the political impact seem to have a substantial negative influence on companies FRQ. (3) Ownership structure – low transparency and hierarchal business structures appears to be biggest problems within the corporate governance. (4) Low business ethics – a too corrupt and non-moral business structure threatens the integrity of the financial reports. (5) Tax avoidance – the unwillingness to pay taxes makes many companies reduce earnings or hide sales to avoid value added tax (VAT). (6) Cost reduction – The high endeavor to keep costs down might in many cases also bring effects on the quality of disclosed material.