Earnings Inflation Through Accruals and Real Activity Manipulation: Its Prevalence at the Time of an SEO and the Financial Market Consequences

46 Pages Posted: 20 Nov 2007

See all articles by Natalie Mizik

Natalie Mizik

University of Washington

Robert Jacobson

Diogenes Consulting; University of Washington - Michael G. Foster School of Business

Date Written: June 4, 2007

Abstract

We find evidence that some firms attempt to inflate current-term earnings (and thereby stock price) at the time of a seasoned equity offering (SEO). Earnings inflation takes place both through accruals and real activity earnings management. The financial markets do not properly value firms inflating earnings. This mis-valuation (i.e., overvaluation) is more closely linked to real activity manipulation rather than accruals manipulation. We find that only those firms classified as having a greater likelihood to have engaged in real earnings management have significantly lower future-term stock returns compared to other firms issuing an SEO. This mis-valuation occurs regardless of whether the firm had positive or negative abnormal accruals.

Keywords: Earnings Management, Accruals, Real Activity Manipulation, Seasoned Equity Offering, SEO Mispricing, Myopic Management

JEL Classification: G14

Suggested Citation

Mizik, Natalie and Jacobson, Robert, Earnings Inflation Through Accruals and Real Activity Manipulation: Its Prevalence at the Time of an SEO and the Financial Market Consequences (June 4, 2007). Available at SSRN: https://ssrn.com/abstract=1031006 or http://dx.doi.org/10.2139/ssrn.1031006

Natalie Mizik (Contact Author)

University of Washington ( email )

Seattle, WA 98195
United States

Robert Jacobson

Diogenes Consulting ( email )

2002 1st Avenue North
Seattle, WA 98109
United States

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States
206-543-4780 (Phone)

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