“Shall Absolute Power Corrupt Absolutely?”: A Perspective From Financial Constraints and Earnings Quality Under Government Control

Abstract

This research investigates the efficacy of government control in the context of financial constraints and earnings quality, focusing on Vietnam’s listed companies. Employing a dynamic approach and utilizing the System Generalized Method of Moments (SGMM) to mitigate endogeneity concerns, the study examines annual data from non-financial Vietnamese firms listed on the Hanoi and Ho Chi Minh Stock Exchange (HNX & HOSE) spanning 2012 to 2022. Non-financial firms are the study’s main focus because their operational dynamics, capital structures, and strategic priorities markedly differ from their financial counterparts. Moreover, non-financial companies in Vietnam contend with multifaceted challenges arising from government control including potential bureaucratic hurdles, regulatory constraints, and strategic limitations, directly affecting their financial flexibility, and consequently their ability to ensure earnings quality. Earnings quality is assessed through the average values of four key characteristics—persistence, predictability, variability, and smoothness—while financial constraints are proxied by firm size, foundation years, financial leverage, and dividend pay-outs. Findings reveal a deleterious impact of financial constraints on earnings quality, with state ownership exhibiting varying effects at different levels. Remarkably, the optimal range for state ownership, specifically State-Owned Enterprises (SOEs) rates from 35% to 50%, is identified as pivotal in ameliorating the adverse consequences of financial constraints on earnings quality. The research acknowledges limitations in the exclusive focus on specific earnings characteristics and the potential multicollinearity issue arising from the interaction variable in the SGMM model. Practically, the study proposes policies emphasizing the need for investors to discern financial constraint signals, companies to mitigate financial constraints, and governments to play a pivotal role in alleviating financial constraints to enhance earnings quality. Socially, the research underscores the imperative nature of earnings quality in investment decisions, cautioning against investing in companies masking inefficiencies with manipulated profits, thereby posing risks to individual investors and the overall financial market. The originality of this study lies in its alternative representations of financial constraints, nuanced examination of state ownership at different levels, and its elucidation of the moderating role of state ownership in the relationship between financial constraints and earnings quality.