Causes or consequences: Earnings management around seasoned equity offerings

Abstract: Prior studies find that earnings management around seasoned equity offerings is negatively related to subsequent stock performance and attribute the finding to the issuing firms ’ use of inflated earnings to boost stock prices. We show in this paper that earnings management is not significantly related to concurrent abnormal returns. Rather, it is significantly positively related to prior abnormal returns. This suggests that, rather than a cause of stock price run-up, earnings management is likely a consequence of the stock overvaluation prior to the offerings, supporting the agency theory of overvalued equity (Jensen, 2005). We also show that when examining the relation between earnings management and subsequent stock performance, one has to be careful with the appropriate window for measuring earnings management