The impact of the 2007 reforms in China on the quality of earnings

Abstract

Prior to 2007, in order to encourage international investment, China operated two parallel financial reporting systems, one based on Chinese GAAP for domestic investors and the other based on IFRS for international investors. In 2007 after a series of reforms to harmonise Chinese GAAP with IFRS, this system was replaced by a single set of standards for both classes of investor. We evaluate the impact of this significant change on earnings quality for stocks quoted on the Shanghai and Shenzhen stock exchanges for the period 2003-2013. Using tests of earnings smoothing and early loss recognition, we identify three key features. Firstly, earnings quality improved consistently over the period. Secondly, prior to the reforms of 2007, IFRS earnings were of superior quality to Chinese GAAP earnings. A third and important finding is that earnings quality under Chinese GAAP after the 2007 reforms is comparable to that under pre-2007 IFRS.