Finance Research Letters 58 (2023) 103906

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Finance Research Letters

journal homepage: www.elsevier.com/locate/frl

Centralized Drug Procurement and asymmetric earnings

management: Evidence from China
Sha Xu, Dejun Wu *
School of Accounting, Zhongnan University of Economics and Law, Wuhan, China

A R T I C L E I N F O A B S T R A C T

Keywords:
Pharmaceutical regulation
Centralized drug procurement policy
Asymmetric earnings management
Using a difference-in-differences approach, we study the impact of Centralized Drug Procurement
(CDP) on the earnings management of pharmaceutical firms in China. We find an asymmetric
earnings management effect that winning firms manage earnings upward, whereas losing firms
manage earnings downward. Further analyses show that upward earnings management by win­
ning firms is stronger for firms with more analysts following, shares pledged, and strong
competition, whereas downward earnings management by losing firms is more pronounced for
young firms, non-state-owned enterprises, and high government subsidy firms.

1. Introduction

As a common pharmaceutical regulation designed to lower health expenditure, Centralized Drug Procurement (CDP) requires a
buyer group to aggregate drug purchasing volume, thus decreasing drug prices. Under CDP policy, competitive bidding is efficient and
ensures that manufacturers offer the lowest prices. CDP lowers drug prices and enhances transparency and governance, ultimately
benefitting patients (Wang et al., 2021). However, CDP policy also distorts supply-side incentives (Callejas and Mohapatra, 2021),
leads to a bilateral oligopoly (Weinstein, 2006), and alters private equilibrium prices (Duggan and Scott Morton, 2006). Consequently,
pharmaceutical firms may experience exogenous shocks from CDP policy.
Earnings can be managed in different directions. Managers may manage earnings upward to meet the expectations of analysts
(Beardsley et al., 2021), maintain overvaluation (Badertscher, 2011), or meet the requirements of compensation and lending contracts
(DeAngelo et al., 1994; Healy, 1985). However, managers may also manage earnings downward to take a “big bath” (Kirschenheiter
and Melumad, 2002), obtain more government subsidies (Wallsten, 2000), or avoid scrutiny risk (Glegg et al., 2021). Managers choose
appropriate earnings management methods to deal with exogenous shocks (Zang, 2012). Although CDP is a pharmaceutical regulation
that intensifies industry competition and influences the performance of drug makers, winning firms (i.e., firms that win CDP bids) and
losing firms (i.e., firms that lose CDP bids) face different changes in earnings and manage earnings differently. However, only limited
research addresses whether and how the managers of winning and losing firms manipulate earnings when faced with CDP. We aim to
fill this gap and explore the potential impact of CDP on firms’ earnings management behavior.
We posit that CDP leads to an asymmetric earnings management effect. Winning firms have the incentive to manage earnings
upward to meet market expectations. Firms with major government customers enjoy steady cash flows, have better access to capital
markets, and face lower demand uncertainty (Cohen and Li, 2020; Dhaliwal et al., 2016). The winning of CDP bids entails that firms
will secure a large market share and lower the cost of sales. Thus, investors and analysts drive up market expectations for winning

* Corresponding author.
E-mail address: djwu2005@163.com (D. Wu).

https://doi.org/10.1016/j.frl.2023.103906
Received 17 February 2023; Received in revised form 10 April 2023; Accepted 13 April 2023
Available online 14 April 2023
1544-6123/© 2023 Elsevier Inc. All rights reserved.
S. Xu and D. Wu Finance Research Letters 58 (2023) 103906

firms. If winning firms fail to meet analysts’ forecasts, their stock price and reputation are likely to be punished by the capital market
(Skinner and Sloan, 2002). Under this market pressure, managers behave more myopically (Bhojraj and Libby, 2005), for example by
chasing short-term performance through upward earnings management. In contrast, losing firms are incentivized to manage earnings
downward and take a “big bath.” The loss of CDP bids entails that firms will lose a large part of their market share and revenues will
plummet. When confronted with bad news, managers are incentivized to under-report earnings to facilitate future favorable earnings
comparisons (Kirschenheiter and Melumad, 2002). In addition, some losing firms are likely to seek government subsidies through
negative earnings management. Thus, we propose an asymmetric earnings management effect triggered by CDP: winning firms
manage earnings upward to meet, whereas losing firms manage earnings downward to bathe.
China provides a unique setting to examine the potential effect of pharmaceutical regulation on earnings management. In 2018,1
total Chinese pharmaceutical expenditure accounted for 32.29% of total health expenditure—higher than the 17% average in Or­
ganization of Economic Co-operation and Development countries (Wang et al., 2021). Patients in China bear a heavy financial burden
because of unreasonably high drug prices. In China, many common drugs are priced two to three times higher than those in other key
economies, whereas sales expenses of mainstream pharmaceutical companies account for nearly 40% of their sales revenues.2 To ease
the financial burden on patients, China has enforced a series of medical regulations of which CDP is representative. Specifically, the
country has held seven rounds of national CDP covering 294 medications since 2018. Drug prices were lowered by over 50% in the last
six rounds.3 Chinese pharmaceutical companies are affected considerably by pharmaceutical regulations, which increase competition.
Therefore, in the context of industry reshuffle and performance volatility, drug producers in China have a greater incentive to manage
earnings.
Using a difference-in-differences (DID) approach, we study the impact of CDP on firms’ earnings management behavior in China.
We find that winning firms manage earnings upward, whereas losing firms manage earnings downward. Furthermore, upward
earnings management by winning firms is stronger for firms with more analysts following, shares pledged, and strong market
competition, whereas downward earnings management by losing firms is more pronounced for young firms, non-state-owned en­
terprises (non-SOEs), and high government subsidy firms.
This study makes the following contributions. First, to the best of our knowledge, our study is the first to examine the policy effect of
CDP on earnings management. The literature focuses on the effect of CDP on price (Wang et al., 2021), welfare (Callejas and
Mohapatra, 2021), and market competition structure (Weinstein, 2006). We find that CDP policy intensifies earnings management by
managers. Second, our findings enrich the literature on asymmetric earnings management by providing empirical evidence from
China. We find that CDP policy leads to asymmetric earnings management by pharmaceutical firms. Specifically, managers of winning
bids manage earnings upward, whereas managers of losing bids manage earnings downward.

2. Data and methodology

Our sample includes Chinese listed firms in pharmaceutical industry between 2015 and 2021.4 CDP bidding results are from the
official website of China’s National Healthcare Security Administration (https://www.smpaa.cn/). Other data are obtained from the
China Stock Market & Accounting Research database. We exclude 71 observations that are associated with financially stressed firms
and 299 observations with missing data. Therefore, the winning-treated sample contains 1167 firm-year observations. We exclude 60
successful observations in the losing-treated sample because these losing firms later won bids. Therefore, the losing-treated sample
contains 1107 firm-year observations. We winsorize all continuous variables at the 1% and 99% levels.
We use the modified Jones model Dechow et al., 1995) to calculate accrual-based earnings management (AEM) in Eqs. (1) to ((3)
and the Roychowdhury (2006) model to calculate real earnings management (REM) in Eqs. (4) to (7). Finally, we use the sum of AEM
and REM to measure total earnings management (TEM).
/ / / /
TACi,t Ai,t− 1 = β1 1 Ai,t− 1 + β2 ΔREVi,t Ai,t− 1 + β3 PPEi,t Ai,t− 1 + εi,t (1)
/ ( )/ /
NDACi,t = β1 1 Ai,t− 1 + β2 ΔREVi,t − ΔRECi,t Ai,t− 1 + β3 PPEi,t Ai,t− 1 (2)
/
DACi,t = TACi,t Ai,t− 1 − NDACi,t (3)
/ / / /
CFOi,t Ai,t− 1 = β0 + β1 1 Ai,t− 1 + β2 Salei,t Ai,t− 1 + β3 ΔSalei,t Ai,t− 1 + ε1i,t (4)
/ / / / /
PRODi,t Ai,t− 1 = β0 + β1 1 Ai,t− 1 + β2 Salei,t Ai,t− 1 + β3 ΔSalei,t Ai,t− 1 + β4 ΔSalei,t− 1 Ai,t− 1 + ε2i,t (5)
/ / /
DISEXPi,t Ai,t− 1 = β0 + β1 1 Ai,t− 1 + β2 Salei,t Ai,t− 1 + ε3i,t (6)

REMi,t = − ε1i,t + ε2i,t − ε3i,t , (7)

1
2018 was the first year of the national CDP regulation.
2
http://www.chinadaily.com.cn/a/202108/28/WS6129a3ffa310efa1bd66bc33.html
3
http://www.chinadaily.com.cn/a/202208/09/WS62f1c32ba310fd2b29e711fa.html
4
This range is selected because China’s national CDP policy started in 2018.

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S. Xu and D. Wu Finance Research Letters 58 (2023) 103906

Table 1
Definitions of variables.
Variable Definition

AEM Accrual-based earnings management measured by the modified Jones (Dechow et al., 1995) model.
REM Real earnings management measured by the Roychowdhury (2006) model.
TEM The sum of accrual-based and real earnings management.
TREAT_WINNER A dummy variable that equals 1 in the year that the firm won for the first time and in the following year, and 0 otherwise.
TREAT_LOSER A dummy variable that equals 1 in the year that the firm lost for first time and in the following year, and 0 otherwise.
SIZE Natural logarithm of total assets.
LEV Debt divided by total assets.
GROWTH The difference in total assets between the current and previous years divided by total assets in the previous year.
CFO Cash flow from operating activities divided by total assets.
ROA Net income divided by total assets.
BIG4 Equals 1 for all firm-year observations audited by international Big 4 audit firms and 0 otherwise.
TATO Total asset turnover. Net sales divided by total assets.
INDRATIO Percentage of independent directors.
DUAL Equals 1 if the board chair serves as CEO and 0 otherwise.
BOARDSIZE The number of board members.
MARKETSHARE Share of market revenues.
MGT Proportion of managers.
ANALYSTFOLLOW The number of analysts providing earnings forecasts.

Table 2
Descriptive statistics.
Variable N Mean Standard Deviation Min Median Max

AEM 1167 0.003 0.064 − 0.173 0 0.195

REM 1167 − 0.017 0.261 − 0.821 0.008 0.531
TEM 1167 − 0.014 0.275 − 0.774 0.003 0.591
TREAT_WINNER 1167 0.098 0.297 0 0 1
TREAT_LOSER 1167 0.191 0.393 0 0 1
SIZE 1167 22.150 0.911 20.380 22.110 24.390
LEV 1167 0.308 0.159 0.046 0.289 0.752
GROWTH 1167 0.157 0.357 − 0.523 0.095 5.467
CFO 1167 0.086 0.117 − 0.247 0.077 2.930
ROA 1167 0.060 0.081 − 0.847 0.057 0.604
BIG4 1167 0.051 0.221 0 0 1
TATO 1167 0.542 0.225 0.118 0.524 1.233
INDRATIO 1167 0.373 0.048 0.333 0.333 0.500
DUAL 1167 0.338 0.473 0 0 1
BOARDSIZE 1167 8.465 1.484 5 9 14
MARKETSHARE 1167 0.006 0.008 0 0.003 0.042
MGT 1167 0.095 0.146 0 0.005 0.572
ANALYSTFOLLOW 1167 6.620 9.796 0 2 68

where Ai,t-1 is a firm’s total assets at the end of year t− 1; TACi,t is total accruals for firm i in year t and is defined as net income from
continuing operations minus operating cash flow; ΔREVi,t is the change in revenues for firm i at the end of year t; ΔRECi,t is the change
in accounts receivable for firm i at the end of year t; PPEi,t is fixed assets at the end of year t; CFOi,t is a firm’s operating cash flow at the
end of year t; PRODi,t is the total operating and inventory costs for a firm at the end of year t; DISEXPi,t is the sum of selling and
administrative expenses for a firm at the end of year t; and Salei,t denotes the operating revenue of a firm at the end of year t.
We conduct the following time-varying DID estimation to assess the impact of CDP on firms’ earnings management:
∑ ∑ ∑
EMi,t = β0 + β1 TREATi,t + βk Controlsi,t + FIRM + YEAR + εi,t (8)

In Equation (8), the independent variable is earnings management (EM), which contains AEM, REM, and TEM. The dependent
variable is TREAT, which contains TREAT_WINNER (representing winners) and TREAT_LOSER (representing losers). We identify
winning firms from official announcements. We identify losing firms as those that mention in the management discussion and analysis
section5 of their annual reports medication bids that are known not to have been winning bids at the time. The key study variables are
listed in Table 1.

5
The management discussion and analysis section is an important part of annual reports that reviews a company’s main products and business
plan. Because firms do not report their list of unsuccessful bids, we use a textual analysis approach to identify losing firms.

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S. Xu and D. Wu Finance Research Letters 58 (2023) 103906

Table 3
Baseline analysis of the relationship between CDP and earnings management.
Variable (1) (2) (3) (4) (5) (6)
AEM REM TEM AEM REM TEM

TREAT_WINNER 0.003 0.033* 0.037** – – –

(0.83) (1.79) (2.01) – – –
TREAT_LOSER – – – − 0.010*** − 0.048*** − 0.058***
– – – (− 2.92) (− 2.67) (− 3.11)
SIZE 0.015** − 0.005 0.011 0.013* − 0.007 0.007
(2.34) (− 0.11) (0.25) (1.75) (− 0.15) (0.14)
LEV 0.002 0.055 0.054 − 0.001 0.050 0.047
(0.10) (0.64) (0.60) (− 0.04) (0.55) (0.50)
GROWTH 0.045*** − 0.003 0.041 0.047*** − 0.008 0.039
(4.66) (− 0.13) (1.36) (4.94) (− 0.32) (1.22)
CFO − 0.714*** − 1.082*** − 1.781*** − 0.716*** − 1.072*** − 1.781***
(− 13.30) (− 9.97) (− 12.84) (− 12.74) (− 9.92) (− 12.75)
ROA 0.566*** − 0.152 0.406*** 0.548*** − 0.135 0.407***
(5.22) (− 1.29) (2.96) (5.13) (− 1.15) (3.03)
BIG4 − 0.015 0.019 0.001 − 0.014 0.016 − 0.000
(− 0.85) (0.34) (0.02) (− 0.77) (0.28) (− 0.00)
TATO 0.005 − 0.103 − 0.093 0.008 − 0.106 − 0.096
(0.26) (− 1.11) (− 1.02) (0.43) (− 1.15) (− 1.04)
INDRATIO − 0.083* − 0.063 − 0.137 − 0.087* − 0.257 − 0.334
(− 1.69) (− 0.24) (− 0.51) (− 1.70) (− 0.96) (− 1.22)
DUAL − 0.003 − 0.016 − 0.017 − 0.002 − 0.024 − 0.026
(− 0.74) (− 1.01) (− 1.08) (− 0.55) (− 1.39) (− 1.41)
BOARDSIZE − 0.003* − 0.009 − 0.013 − 0.004* − 0.016 − 0.020*
(− 1.68) (− 0.98) (− 1.28) (− 1.85) (− 1.56) (− 1.88)
MARKETSHARE 0.484 9.666** 9.958** 0.647 9.692** 10.216*
(0.55) (2.38) (2.13) (0.62) (2.02) (1.85)
MGT 0.009 0.132 0.131 0.019 0.082 0.096
(0.44) (1.45) (1.37) (0.89) (0.93) (1.02)
ANALYSTFOLLOW 0.001*** 0.000 0.001 0.001*** 0.000 0.001
(2.61) (0.42) (0.94) (2.83) (0.34) (0.88)
_cons − 0.263* 0.257 − 0.028 − 0.209 0.446 0.230
(− 1.76) (0.27) (− 0.03) (− 1.23) (0.47) (0.23)
Observations 1167 1167 1167 1107 1107 1107
Adj R2 0.758 0.245 0.390 0.757 0.239 0.384
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes

Robust t-statistics are in parentheses.

*Significance at the 10% level, **significance at the 5% level, ***significance at the 1% level.

3. Results and discussion

3.1. Descriptive statistics

Table 2 shows the descriptive statistics. The mean of TREAT_WINNER (0.098) is smaller than that of TREAT_LOSER (0.191),
signifying that losing bids are greater than winning bids and supporting that CDP leads to more intense industry competition. The
absolute mean of REM (0.017) is larger than that of AEM (0.003), signifying that pharmaceutical firms prefer to manage earnings
through real activities—a form of earnings management that is more difficult to detect than accrual-based earnings management.

3.2. Baseline analysis

Table 3 shows the asymmetric effect of CDP on the earnings management of pharmaceutical firms. The results in columns (1) to (3)
illustrate the impact of CDP on winning bids. The coefficients of TREAT_WINNER in columns (1) to (3) are all positive and the co­
efficients of TREAT_WINNER in columns (2) and (3) are significant at the 10% level, signifying that CDP intensifies upward earnings
management in winning bids and that managers of winning bids are more likely to choose real earnings management than accrual-
based earnings management to prevent detection.
The results in columns (4) to (6) illustrate the impact of CDP on losing bids. The coefficients of TREAT_LOSER in columns (4) to (6)
are negative and significant at the 1% level.

3.3. Robustness checks

We perform a series of robustness checks including a parallel trend assumption test, a placebo test, and the use of an alternative
dependent variable.

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S. Xu and D. Wu Finance Research Letters 58 (2023) 103906

Table 4
Robustness checks.
Panel A: Parallel trend assumption
Variable (1) (2) (3) (4) (5) (6)

AEM REM TEM AEM REM TEM

PRE − 3 0.001 0.027 0.026 − 0.001 0.004 0.004
(0.14) (1.23) (1.22) (− 0.34) (0.17) (0.21)
PRE − 2 0.009 0.019 0.026 − 0.001 0.013 0.014
(1.32) (0.79) (1.01) (− 0.18) (0.63) (0.62)
POST 0 0.004 0.009 0.015 − 0.013*** − 0.049*** − 0.060***
(0.94) (0.52) (0.79) (− 3.09) (− 2.89) (− 3.30)
POST 1 0.010* 0.063** 0.072*** − 0.007 − 0.040* − 0.047**
(1.66) (2.24) (2.62) (− 1.20) (− 1.89) (− 2.08)
POST 2+ 0.002 0.105** 0.106** − 0.003 − 0.009 − 0.010
(0.17) (2.20) (2.17) (− 0.52) (− 0.31) (− 0.34)
POST 3+ 0.005 0.087*** 0.092** − 0.013* 0.004 − 0.008
(0.35) (2.64) (2.28) (− 1.93) (0.09) (− 0.19)
Controls Yes Yes Yes Yes Yes Yes
Observations 1167 1167 1167 1107 1107 1107
Adj R2 0.758 0.247 0.391 0.756 0.238 0.383
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes

Panel B: Placebo test left to the actual event (2018–2021 vs. 2014–2017)
Variable (1) (2) (3) (4) (5) (6)

AEM REM TEM AEM REM TEM

TREAT_WINNER_PLACEBO − 0.004 − 0.017 − 0.023 – – –
(− 1.05) (− 0.72) (− 0.98) – – –
TREAT_LOSER_PLACEBO – – – − 0.001 0.013 0.012
(− 0.32) (0.72) (0.68)
Controls Yes Yes Yes Yes Yes Yes
Observations 1167 1167 1167 1107 1107 1107
Adj R2 0.791 0.354 0.520 0.792 0.330 0.515
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes

Panel C: Alternative measure of earnings management

Variable (1) (2) (3) (4)

AEM_NEW TEM_NEW AEM_NEW TEM_NEW

TREAT_WINNER 0.002 0.035* – –
(0.44) (1.89)
TREAT_LOSER – – − 0.010*** − 0.058***
– – (− 2.74) (− 3.09)
Controls Yes Yes Yes Yes
Observations 1167 1167 1107 1107
Adj R2 0.791 0.354 0.520 0.792
Year FE Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes

Robust t-statistics are in parentheses.

*Significance at the 10% level, **significance at the 5% level, ***significance at the 1% level.

First, the parallel trend assumption—a curial premise of the DID analysis—requires no material distinction between treated and
control firms before the implementation of CDP policy Amiram et al., 2017). Following Bertrand & Mullainathan (2003), we create
seven dummy variables (PRE − 3, PRE − 2, PRE − 1, POST 0, POST 1, POST 2+, POST 3+) for the treated firms in years t − 3, t − 2, t − 1,
t, t + 1, t + 2, and t + 3. We exclude the year before deregulation (Beck et al., 2010). In Panel A of Table 4, the coefficients of Pre − 3 and
Pre − 2 are not significant in columns ((1) to (3)—i.e., belonging to winners—and in columns (4) to (6)—i.e., belonging to loser­
s—signifying no substantial differences between treated and control firms before CDP implementation.
Second, as the treated and control firms may behave differently even without CDP because of fundamental differences between
these groups, we conduct a placebo test to control for this effect. Following Nyborg & Wang (2021), we shift the regulation imple­
mentation time by 4 years to the left and construct placebo proxies for TREAT_WINNER (TREAT_WINNER_PLACEBO) and TREAT_­
LOSER (TREAT_LOSER_PLACEBO). If our baseline analysis is valid, the coefficients of TREAT_WINNER_PLACEBO and
TREAT_LOSER_PLACEBO should not be significant; Panel B of Table 4 shows the expected results.
Finally, we use an alternative method to calculate accrual-based and total earnings management. Following Jones (1991), we use
the residuals from Eq. (9) to measure accrual-based earnings management (AEM_NEW) and total earnings management (TEM_NEW).
The results in Panel C of Table 4 show that our baseline results are robust. The variable definition of Eq. (9) is consistent with that of
Eq. (7).
/ / / /
TACi,t Ai,t− 1 = β1 1 Ai,t− 1 + β2 ΔREVi,t Ai,t− 1 + β3 PPEi,t Ai,t− 1 + εi,t (9)

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S. Xu and D. Wu Finance Research Letters 58 (2023) 103906

Table 5
Additional analysis: Subsample tests of winning firms.
Panel A: Subsample test based on analysts following
Variable (1) (2) (3) (4) (5) (6)
High analysts following Low analysts following
DAC REM TEM DAC REM TEM

TREAT_WINNER 0.001 0.041* 0.042* 0.010 0.064 0.074*

(0.25) (1.86) (1.89) (0.86) (1.52) (1.77)
Controls Yes Yes Yes Yes Yes Yes
Observations 720 720 720 447 447 447
Adj R2 0.878 0.273 0.443 0.696 0.306 0.431
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes

Panel B: Subsample test based on share pledging by controlling shareholders

Variable (1) (2) (3) (4) (5) (6)
Shares pledged by controlling shareholders Shares not pledged by controlling shareholders
DAC REM TEM DAC REM TEM

TREAT_WINNER 0.004 0.054* 0.060** 0.005 0.025 0.030

(0.74) (1.86) (2.02) (0.92) (0.97) (1.20)
Controls Yes Yes Yes Yes Yes Yes
Observations 617 617 617 563 563 563
2
Adj R 0.812 0.313 0.411 0.743 0.243 0.417
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes
Panel C: Subsample test based on competition

Variable (1) (2) (3) (4) (5) (6)

High competition Low competition
DAC REM TEM DAC REM TEM

TREAT_WINNER 0.005 0.049* 0.054** − 0.003 0.003 0.003

(0.72) (1.87) (2.01) (− 0.57) (0.11) (0.12)
Controls Yes Yes Yes Yes Yes Yes
Observations 586 586 586 581 581 581
Adj R2 0.800 0.237 0.425 0.821 0.308 0.409
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes

Robust t-statistics are in parentheses.

*Significance at the 10% level, **significance at the 5% level, ***significance at the 1% level.

3.4. Additional analysis

We further explore the impact of analyst following, share pledging, and competition on winning firms’ earnings management
behavior caused by CDP, and firm age, enterprise property, and government subsidies on losing firms’ earnings management behavior.

3.4.1. The effect of pressure from analysts, shareholders, and peers on winners
Managers face more pressure to meet analyst forecasts in winning firms that have more analysts following, shares pledged, and
strong competition.6
First, more analyst coverage leads to more market pressure on and scrutiny of listed firms. Therefore, managers are prone to
manage earnings upward to meet analyst forecasts (Irani and Oesch, 2016). Using the median value of ANALYSTFOLLOW, we partition
the full sample into high-analyst-following and low-analyst-following subsamples. We expect the coefficients of REM and TEM to be
significant for the high-analyst-following subsample and not significant for the low-analyst-following subsample.
Second, controlling shareholders tend to manage earnings to drive up stock prices and increase the value of collateral (Huang and
Xue, 2016). Managers of winning firms whose controlling shareholders pledge shares have a greater incentive to engage in upward
earnings management than those whose shareholders do not pledge shares. In Panel B of Table 5, we partition the full sample into two
groups based on whether shares are pledged by controlling shareholders. We expect the coefficients of REM and TEM to be significant
in the subsample that includes share pledging by controlling shareholders.
Third, strong competition adds performance pressure on managers and drives managers to manipulate earnings upward (Shleifer,
2004). Following Shaffer & Spierdijk (2020), we use the Lerner index7 to measure competition. A low value on the Lerner index means

6
Indeed, meeting analyst earnings forecasts is positively associated with a good reputation among analysts, a steady value of collateral for
shareholders, and strong competitive advantages for managers (Kassznik and McNichols, 2002).
7
The Lerner index is the difference between operating revenue and the sum of operating costs, sale expenses and overhead expenses, divided by
operating revenue.

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Table 6
Additional analysis: Subsample tests of losing firms.
Panel A: Subsample test based on firm age
Variable (1) (2) (3) (4) (5) (6)
Mature firms Young firms
AEM REM TEM AEM REM TEM

TREAT_LOSER 0.001 − 0.002 − 0.001 − 0.016*** − 0.054** − 0.069***

(0.42) (− 0.07) (− 0.05) (− 2.76) (− 2.26) (− 2.64)
Controls Yes Yes Yes Yes Yes Yes
Observations 500 500 500 607 607 607
Adj R2 0.887 0.258 0.419 0.692 0.340 0.456
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes

Panel B: Subsample test based on enterprise property

Variable (1) (2) (3) (4) (5) (6)
SOE Non-SOE
AEM REM TEM AEM REM TEM

TREAT_LOSER − 0.003 − 0.035 − 0.038 − 0.011** − 0.045** − 0.056**

(− 0.56) (− 1.09) (− 1.16) (− 2.59) (− 2.11) (− 2.54)
Controls Yes Yes Yes Yes Yes Yes
Observations 253 253 253 854 854 854
Adj R2 0.873 0.308 0.496 0.738 0.250 0.376
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes

Panel C: Subsample test based on future government subsidies

(1) (2) (3) (4) (5) (6)
High future government subsidies Low future government subsidies
Variable AEM REM TEM AEM REM TEM

TREAT_LOSER − 0.010** − 0.044** − 0.054** − 0.002 − 0.021 − 0.025

(− 2.29) (− 2.08) (− 2.47) (− 0.37) (− 0.66) (− 0.79)
Controls Yes Yes Yes Yes Yes Yes
Observations 719 719 719 386 386 386
Adj R2 0.789 0.288 0.430 0.831 0.253 0.430
Year FE Yes Yes Yes Yes Yes Yes
Firm FE Yes Yes Yes Yes Yes Yes

Robust t-statistics are in parentheses.

*Significance at the 10% level, **significance at the 5% level, ***significance at the 1% level.

that a firm faces more competition. Using the median Lerner index value, we partition the full sample into a high-competition group
and a low-competition group.
The results in Table 5 are consistent with our expectations.

3.4.2. The impact of firm age, enterprise property, and government subsidies on losers
Managers of losing firms are more likely to manage earnings downward when firms are young, non-SOEs, and seek more subsidies.
First, compared with mature firms, young firms are more likely to manage earnings because of stronger performance pressure and
incomplete internal governance. Compared with conditions in mature firms, the stronger performance pressure on managers of young
firms (Erickson et al., 2006) leads to myopic behavior. In addition, young firms do not yet have a sound organizational system to
restrict managers (Lee and Shevlin, 2016). Moreover, managers of young firms are afforded decision-making flexibility (Allen et al.,
2022), which gives them scope to manipulate earnings. Therefore, we posit that the relationship between CDP and earnings man­
agement is stronger in young firms than in mature firms. Following Adhikari & Agrawal (2018), we define firm age as 1 plus the
number of years since the firm’s listing and partition the full sample into mature firms and young firms using the median firm age (11
years).8
Second, compared with state-owned enterprises (SOEs), which have more social objectives and support from the Chinese gov­
ernment (Wei, 2021), we propose that non-SOEs have a greater incentive to manage earnings.
Third, we examine whether losing firms manage earnings downward for government subsidies. Firms may receive more govern­
ment subsidies through negative earnings management (Zhao et al., 2019). Losing firms have a strong incentive to manipulate earnings
to obtain more subsidies—considered “easy money”—to compensate for the loss of CDP. We use the difference in government subsidies
between the current year and the following year to estimate future subsidies and partition the full sample into a high-future-subsidies
group and a low-future-subsidies group using the median subsidy level.
We expect the coefficients of EM to be significant in young firms, non-SOEs, and firms that receive high future subsidies if our

8
In untabulated analyses, we redefine mature (young) firms as firms with an age above the upper (least) quantile or tercile and use cash flow to
classify mature firms (Dickinson, 2011). The results of the subsample tests are consistent with our expectations.

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S. Xu and D. Wu Finance Research Letters 58 (2023) 103906

expectations are valid, the results in Table 6 confirm our expectations.

4. Conclusions

This study examines the impact of CDP on the earnings management behavior of pharmaceutical firms. We find an asymmetric
earnings management effect in which winning firms manipulate earnings upward to meet market expectations, whereas losing firms
manipulate earnings downward to take a “big bath.” The impact of CDP on earnings management behavior is stronger for winning
firms with more analysts following, shares pledged, and high market competition; the impact is more pronounced for losing firms that
are young, are non-SOEs, and receive high government subsidies.

Author statement

Sha Xu: Data curation, Formal analysis, Writing - original draft

Dejun Wu: Conceptualization, Funding acquisition, Methodology, Supervision, Writing - review & editing
Both authors contribute equally to the manuscript.

Data availability

No data was used for the research described in the article.

Acknowledgements

Dejun Wu acknowledges financial support from the National Social Science Foundation of China (20BGL075).

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