Why do Private Firms Introduce State-owned Shareholders? Evidence from Downward Earnings Management

More than 60% of private listed firms in China have turned into a mixed ownership structure by introducing state-owned shareholders, but so far no research has distinguished whether the private firms rush to the mixed ownership reform (hereafter MOR) to get important resource or to seek protection, about which the discussion will help to clarify the most urgent points of our private economy. We note that the resource hypothesis and the protection hypothesis have different theoretical expectations of the relationship between the MOR of private firms and their downward earnings management, which provides an excellent setting for clarifying the motivation for private firms to carry out the MOR. Specifically, the resource hypothesis believes that based on factors such as political costs and capital management capabilities, the higher the degree of MOR of private firms, the higher the degree of their downward earnings management or there exists no significant difference. However, the protection hypothesis holds that if private firms carry out the MOR for property rights protection, their need for hiding wealth will decrease, and the degree of downward earnings management should be significantly lower. Using China’s A-share private listed firms from 2004 to 2018, we find that private firms will significantly reduce their downward earnings management after the MOR. Moreover, the greater the private firm’s need for hiding wealth and the protection the state-owned shareholders could bring, namely, when private firms face greater risks of predation, their ability to pay is stronger or their ability to refuse to pay is weaker, the more obvious negative relationship between the MOR of private firms and their downward earnings management. Further, the greater the protection brought by state-owned shareholders with higher administrative levels, larger scales, or older ages, the more obvious the negative relationship between the MOR of private firms and their downward earnings management. This paper concludes that seeking protection rather than getting resource is the main reason for private firms to have the MOR. From a unique perspective of downward earnings management, this paper not only provides new ideas and evidence for understanding and clarifying the motivations for the MOR of private firms in China, but also reveals the importance of “who to mix with” to provide a brand-new perspective for related research. Our findings also remind relevant departments that the most urgent pain point of our private economy should be property rights protection rather than resource constraints. Encouraging SOEs, especially central SOEs, to participate in the MOR of high-quality private firms with high shelter needs is not only an effective way to strengthen private economy, but also conducive to the effective integration of different ownership economies and improving the efficiency of the MOR.