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Introduction
Earnings quality has drawn a great deal of attention from academics and entrepreneurs because it incorporates much more information on corporate operations and financial reporting, and may consequently impact corporate performance. Two types of definition of earnings quality are frequently referenced. One type of definition concerns the degree to which the quantity of earnings reflects a firm's economic reality (Dechow and Schrand, 2004; Chan et al. , 2006; Hodge, 2003). In other words, earnings quality denotes that the financial statement reports accurately and impartially the firm's corporate operating status and financial position. In this definition, a close match between earnings and cash flow is viewed as high quality, because earnings may be manipulated by inflating accruals. The other type of definition recognizes earnings quality as the degree to which earnings persist or are sustained into the next period (Richardson et al. , 2005, 2006; Revsine et al. , 1999). In this definition, high variation and volatility of earnings is viewed as low quality because earnings uncertainty is a risk for corporate operation and adds to the cost of capital.
The relevant literature claims that having high-quality earnings is a desirable trait in companies. Poor earnings quality is characterized by unhealthy profitability and/or untrue financial information, and is thus detrimental to investors and other users of financial statements. Low-quality earnings can lead to a misallocation of capital, and may generate inappropriate outcomes for contracts that use accounting data as inputs (Schipper and Vincent, 2003). Low-quality earnings also introduce an information risk to investors, and thereby increase the cost of capital (Francis et al. , 2004). The positive relationship between earnings quality and corporate performance is theoretically proved.
However, empirical result seems not always to provide evidence that high earnings quality is associated with high corporate performance and vice versa. Chan et al. (2006) examine the market valuation of earnings quality. They find that increased earnings accompanied by high accruals suggest low earnings quality. Penman and Zhang (2002) document that growth firms in sales or net operating assets are accompanied with lower earnings quality. In this research on Chinese publically listed firms, we find that earnings quality in majority measures has negative relations with corporate performance. We argue that this negative association can be...