Earnings management before seasoned equity offerings and share repurchases: Empirical analysis during 1990-2008 using U.S. companies

OBJECTIVES OF THE STUDY In this thesis, I analyse if firms that are aggressive in earnings management before both share repurchases and seasoned equity offerings ("SEOs") experience abnormal long-term stock performance. I also study if there is overlap in companies managing earnings aggressively before share repurchases and SEOs. To my knowledge, earnings management studies conducted before have focused either on share repurchases or on SEOs. DATA AND METHODOLOGY The empirical analysis is based on a sample of U.S. listed firms that have executed at least one SEO and one share repurchase in a period from January 1990 to December 2008. Additionally, the sample period is divided into two subperiods to study the effect of Sarbanes-Oxley Act in 2002. The sample consists of 2,026 SEOs and 2,966 open market share repurchases using a set of 1,372 companies listed in NASDAQ, NYSE or AMEX. The methodology in this thesis consists of regression analysis used in two main models. The first is a modified Jones (1991) model to find accrual-based earnings management. The second is Fama & French (1993) three-factor model to detect abnormal long-term stock performance with a calendar-time portfolio method. RESULTS The main finding of the thesis provides an explanation whether the same companies that are aggressive in earnings management have abnormal stock returns deriving from downwards earnings management in share repurchases and upwards earnings management in SEOs. My results show abnormal long-term stock returns that significantly differ from the market benchmark. Firms that conducted a SEO and a share repurchase and were in the most conservative quartile in both before a SEO and a share repurchase had 31.09 percentage points higher compounded 5-year returns than the aggressive quartile in the pre-SOX subperiod of 1990-2002. Additionally, I found a strong correlation between the most aggressive quartile of companies to manipulate earnings before both share repurchases and SEOs. This is contrary to the conservative quartile findings, where correlation was low and discretionary accrual levels differ between share repurchases and SEOs