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
Date Written: June 4, 2007
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
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