Chinese corporate distress prediction using LASSO: the role of earnings management

Li, C., Lou, C., Luo, D. and Kai, X. (2021) Chinese corporate distress prediction using LASSO: the role of earnings management. International Review of Financial Analysis, 76. 101776. ISSN 1057-5219 doi: 10.1016/j.irfa.2021.101776

Abstract/Summary

Motivated by recently increasing accounting manipulation cases and deteriorating economic condition in China, we investigate the importance of a set of earnings management predictors and develop up-to-date distress prediction model with earnings management consideration for the Chinese market. Employing annual firm-level data from January 2014 to December 2018, we find that real earnings management (REM) is robustly selected out as a key distress predictor via the variable selection technique LASSO. Our results consistently show that REM could improve early warning of distressed companies with a slight sacrifice of accuracy in predicting healthy companies. After considering the cost of misclassification, it is confirmed that REM contains incremental information about a forthcoming corporate distress risk. Meanwhile, our results also detect an interesting finding that in China, aggressive real earnings management signals the lower probability of corporate distress, indicating distressed firms have lower capacity to conduct REM.

Item Type	Article
URI	https://reading-clone.eprints-hosting.org/id/eprint/99482
Identification Number/DOI	10.1016/j.irfa.2021.101776
Refereed	Yes
Divisions	Henley Business School > Finance and Accounting
Publisher	Elsevier
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