Earnings Management and the Post-Issue Underperformance In Seasoned Equity Offerings

Abstract:     
Loughran and Ritter (1995) document that firms issuing seasoned equity offerings (SEOs) severely underperform the stock market for three to five years after the offering. Our paper examines the hypothesis that SEO investors are too optimistic because they naively extrapolate earnings trends without fully adjusting for observable discretionary managerial reporting choices. We find that aggressive firms, which report high pre-SEO earnings at the expense of post-SEO earnings by taking high discretionary pre-issue accruals, subsequently perform worse (abnormal stock returns and industry-adjusted net income). Aggressive quartile firms earned a highly significant-50% four-year cumulative abnormal return; conservative quartile firms earn an insignificant-7% four-year cumulative abnormal return. In contrast with discretionary accruals, pre-issue non-discretionary accruals did not predict post-SEO returns.

JEL Classifications: G14, G32, M41

Working Paper Series