Media tone, regulators, and corporate behaviour: evidence from the initial public offering approval regulation in China

There has been ongoing debate about the effectiveness of regulation in terms of resource allocation efficiency. While public interest theory argues that regulation is for the public interest and optimizes resource allocation, the regulatory capture theory argues that regulation creates corruption and rent seeking from regulators, which in turn distorts resource allocation. Different from the registration system of most developed countries, in order to improve the initial public offering (IPO) resource allocation and select high-quality firms to enter the capital market, the Chinese government adopted an approval system. However, rent seeking and post-IPO performance reversals are prevalent in China’s IPO regulation. Therefore, this thesis is concerned about how IPO firms’ behavior, media tone and regulators influence the effectiveness of IPO approval regulation in improving resource allocation efficiency. 

Firstly, this thesis examines whether and how firms influence regulatory decisions through media capture. The thesis shows that higher public relations expenditure reduces negative pre- IPO media tone, and that this relationship is weaker when both IPO firms and media outlets face higher legal punishment risks. By linking incentives for media capture to regulatory decisions, the thesis further shows that a less negative media tone is associated with a higher likelihood of IPO approval. These findings suggest that firms can capture media tone and, thus, obtain preferred IPO approvals from regulators, which in turn reduces resource allocation efficiency in emerging markets. 

Secondly, based on the above argument that negative media tone increases regulatory concerns of IPO firms, this thesis further examines the corporate governance role of the media in shaping earnings management from the perspective of the regulation mechanism. The thesis finds that a negative pre-IPO media tone leads firms to reduce abnormal accruals but increase real transactions manipulation, and ultimately brings about a higher total earnings management in IPO prospectuses. Furthermore, the thesis shows that this influence of media tone on pre- IPO earnings management is stronger when the negative news is from media outlets with high circulation or high credibility or for non-state-owned IPO firms. The thesis employs an instrumental variable approach based on two instruments for media tone to address endogeneity bias, and other robustness tests, and indicates that these results hold. These findings document that, in an emerging economy, the media does not play an effective governance role in restraining earnings management as, although IPO firms reduce abnormal accruals, this is substituted with real earnings management to avoid being punished by regulators. 

Finally, this thesis investigates the oversight role of regulators in identifying earnings management when making regulatory decisions. The thesis finds that, overall, regulators effectively reject IPO firms with higher earnings management in their IPO prospectuses. The thesis further finds that corrupt regulators fail to reject IPO applicants that manage earnings. However, Chinese President Xi Jinping’s anti-corruption campaign has brought about regulators’ inaction, although corrupt regulators have commenced an oversight role. These findings suggest that regulation creates corruption, but that Xi’s anticorruption campaign is only effective in suppressing corrupt regulators rather than improving overall resource allocation efficiency, due to a lack of incentives and accountability mechanisms.