Interconnected ownership and earnings management: Supplier-customer collusion in China's IPO context

To maximize the value of their business alliances, suppliers and their major customers may engage in collusive behavior that leverages information sharing and other cooperative mechanisms. Using a unique financial dataset covering the three years before Chinese firms' initial public offerings (IPOs) and data on the top five customers disclosed in Chinese supplier firms' prospectuses, we examine whether supplier–customer ownership connections facilitate opportunistic accrual-based earnings management. We find that ownership connections are significantly associated with higher pre-IPO earnings management, a result that is robust to an instrumental variable approach, propensity score matching, and alternative definitions of key measures. Further analyses reveal that the IPO review committee of the China Securities Regulatory Commission (CSRC) detects such behavior when earnings manipulation is severe, while investors fail to recognize it at the time of listing but gradually adjust in the post-IPO period. The impact of ownership connections on opportunistic earnings management is more pronounced for firms without political connections, in durable goods industries, and located in regions with a weak legal environment. Overall, our findings suggest that supplier–customer ownership connections can serve as a structural mechanism enabling collusive financial reporting prior to IPOs.