Firm Earnings Persistence over the Business Cycle: Evidence from Listed Companies in China1

Abstract On the basis of the analytical framework of Tomy (2012) and utilising the 2008 financial crisis as a natural experiment, this paper empirically examines the relationship between earnings persistence and the business cycle. First, compared with earnings persistence during expansion periods, earnings persistence significantly declines when the economic climate worsens. Moreover, the cash component of earnings is more sensitive to the business cycle than the accrual component. Second, compared with the earnings persistence of companies audited by non-Big-Four firms, the earnings persistence of companies audited by the Big Four is more susceptible to the business cycle. Third, compared with the earnings persistence of companies with a highly concentrated shareholding, the earnings persistence of companies with a low degree of ownership concentration is more susceptible to the business cycle. The results demonstrate that economic cyclical fluctuations, as the basic economic operation in the macroeconomy, can exert a direct influence on the earnings persistence of enterprises (micro economy) by affecting firm fundamentals as well as earnings management. In addition, the effect of firm fundamentals on earnings persistence is pro-cyclical, while the effect of earnings management on earnings persistence is counter-cyclical. Therefore, the higher the quality of accounting information and corporate governance, the more susceptible earnings persistence is to the business cycle. Our study contributes evidence that will help to determine how, and in what direction, earnings management affects earnings persistence over the business cycle and provides empirical evidence to enhance our understanding of the mechanism through which the business cycle can influence earnings persistence.