Conservatism Management, Underpricing, and the Performance of Seasoned Equity Offerings

Abstract

Using a modified Khan and Watts (2009) method, we find that accounting conservatism in years during which seasoned equity offerings (SEOs) occur is significantly lower than that in the same issuers’ pre-SEO periods or that for non-SEO issuers. The finding is robust to alternative conservatism measures based on the Basu (1997) method and the cumulative previous accruals method. The degree of conservatism and its changes around the time of SEOs are negatively associated with levels of governance and information asymmetry, consistent with the findings of prior studies. Issuers with low conservatism experience less underpricing, suggesting that investors naively extrapolate the effect of low conservatism on earnings. The level of conservatism during the year of an equity offering is negatively associated with post-SEO operating and stock return performance, indicating that SEO issuers with conservative accounting policies are likely to experience underperformance in the post-issue period. Our work adds to the literature by demonstrating that companies opportunistically manage levels of conservatism at the time of SEOs.

Keywords: Conservatism management, Seasoned equity offerings (SEOs), Managerial opportunism, Earnings management, Post-SEO performance

JEL Classification: M4, M41