Accounting-Based Regulation in Emerging Markets: The Case of China's Seasoned Equity Offerings

• Main Authors: WANG, Jiwei, CHEN, Kevin
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2007
• Subjects: Accounting; Business Law, Public Responsibility, and Ethics; Corporate Finance
• Online Access: https://ink.library.smu.edu.sg/soa_research/195; http://dx.doi.org/10.1016/j.intacc.2007.06.001
• Institution: Singapore Management University

In China, listed companies are required to achieve a minimum return on equity (ROE) before they can apply for permission to issue additional shares through seasoned-equity offerings (SEO). We document two benefits of this accounting-based regulation in China. First, this regulation limits the increase in the supply of shares and the dilution of existing share prices. The Chinese stock market reacted positively to the announcement of this accounting-based regulation. Moreover, investors' reactions to SEO, announcements are less negative since the accounting-based regulation was introduced than before the regulation was enacted. The second benefit is that the regulation reduces adverse selection in SEO, as shown by the finding that prior to this regulation, firms below the ROE threshold underperformed the market after their SEO, much like what has been observed in other markets; while those above the threshold outperformed the market. Thus, although positive accounting theory predicts that regulations based on accounting numbers create incentives for managers to manipulate their accounting numbers, accounting-based regulations in China seem to serve some useful purposes.