How Do Financial Constraints Relate to Financial Reporting Quality? Evidence from Seasoned Equity Offerings

53 Pages Posted: 24 Apr 2013 Last revised: 25 Dec 2016

See all articles by Ahmet C. Kurt

Ahmet C. Kurt

Bentley University - Department of Accountancy

Date Written: December 24, 2016

Abstract

This paper examines how constraints on firms’ financing capacity relate to managers’ discretionary accounting choices. Three hypotheses of earnings management — the opportunism hypothesis, the rational expectations hypothesis, and the signaling hypothesis — predict that constrained firms engage in greater upward earnings management than unconstrained firms when selling equity. Using a sample of seasoned equity offerings (SEOs) announced between 1983 and 2014, I find support for this prediction. The relation between financial constraints and earnings management is robust to including controls such as offer size, growth opportunities, analyst following, and chief executive officer equity holdings, as well as to using the instrumental variable approach. Investors’ reaction around and following the SEO announcement supports the rational expectations hypothesis. I find that aggressive earnings management by constrained issuers is associated with lower SEO announcement returns but is not followed by negative abnormal returns in the long run. The evidence suggests that constrained issuers’ aggressive use of income-increasing accruals is an outcome of managerial myopia caused by capital market pressure, not managerial opportunism intended to mislead investors.

Keywords: Earnings Management, Financial Constraints, Seasoned Equity Offerings, Managerial Opportunism, Signaling, Rational Expectations

JEL Classification: G32, M41

Suggested Citation

Kurt, Ahmet C., How Do Financial Constraints Relate to Financial Reporting Quality? Evidence from Seasoned Equity Offerings (December 24, 2016). European Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2255832 or http://dx.doi.org/10.2139/ssrn.2255832

Ahmet C. Kurt (Contact Author)

Bentley University - Department of Accountancy ( email )

175 Forest Street
Waltham, MA 02452
United States

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