Hostname: page-component-78c5997874-lj6df Total loading time: 0 Render date: 2024-11-04T19:13:50.368Z Has data issue: false hasContentIssue false

Earnings Management Surrounding Seasoned Bond Offerings: Do Managers Mislead Ratings Agencies and the Bond Market?

Published online by Cambridge University Press:  01 July 2011

Gary L. Caton
Affiliation:
Montana State University, College of Business, PO Box 173040, Bozeman, MT 59717. [email protected]
Chiraphol N. Chiyachantana
Affiliation:
Singapore Management University, Lee Kong Chian School of Business, 50 Stamford Rd., Singapore 178899. [email protected]
Choong-Tze Chua
Affiliation:
Singapore Management University, Lee Kong Chian School of Business, 50 Stamford Rd., Singapore 178899. [email protected]
Jeremy Goh
Affiliation:
Singapore Management University, Lee Kong Chian School of Business, 50 Stamford Rd., Singapore 178899. [email protected]

Abstract

We study earnings management (EM) efforts surrounding seasoned bond offerings using discretionary current accruals. We find that issuers tend to inflate earnings performance prior to an offering. In order for EM efforts to effectively mislead ratings agencies and the bond market, they must lead to inflated bond ratings and decreased offering yields. Regression results indicate the opposite; aggressive EM efforts are associated with lower initial ratings and higher offering yields. We also find a statistically lower proportion of subsequent downgrades for firms with the most aggressive EM efforts, which is inconsistent with these firms’ inflated initial ratings. While some firms may attempt to mislead ratings agencies and market participants by window-dressing earnings, these efforts appear to be counterproductive.

Type
Research Articles
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Ali, A., and Zhang, W.. “Proximity to Broad Credit Rating Change and Earnings Management.” Working Paper, University of Texas at Dallas (2008).CrossRefGoogle Scholar
Ashbaugh-Skaife, H.; Collins, D. W.; and LaFond, R.. “The Effects of Corporate Governance on Firms’ Credit Ratings.” Journal of Accounting and Economics, 42 (2006), 203243.CrossRefGoogle Scholar
Ball, R., and Shivakumar, L.. “Earnings Quality at Initial Public Offerings.” Journal of Accounting and Economics, 45 (2008), 324349.CrossRefGoogle Scholar
Barber, B. M., and Lyon, J. D.. “Detecting Abnormal Operating Performance: The Empirical Power and Specification of Test Statistics.” Journal of Financial Economics, 41 (1996), 359399.CrossRefGoogle Scholar
Becker, C. L.; DeFond, M. L.; Jiambalvo, J.; and Subramanyam, K. R.. “The Effect of Audit Quality on Earnings Management.” Contemporary Accounting Research, 15 (1998), 124.CrossRefGoogle Scholar
Bergstresser, D., and Philippon, T.. “CEO Incentives and Earnings Management.” Journal of Financial Economics, 80 (2006), 511529.CrossRefGoogle Scholar
Caouette, J. B.; Altman, E. I.; and Narayanan, P.. Managing Credit Risk: The Next Great Financial Challenge. New York, NY: John Wiley and Sons (1998).Google Scholar
DeFond, M. L., and Jiambalvo, J.. “Debt Covenant Violation and Manipulation of Accruals.” Journal of Accounting and Economics, 17 (1994), 145176.CrossRefGoogle Scholar
Degeorge, F.; Patel, J.; and Zeckhauser, R.. “Earnings Management to Exceed Thresholds.” Journal of Business, 72 (1999), 133.CrossRefGoogle Scholar
Demirtas, K. O.; Ghosh, A.; Rodgers, K. J.; and Sokobin, J.. “Initial Credit Ratings and Earnings Management.” Working Paper, City University of New York (2006).Google Scholar
DuCharme, L. L.; Malatesta, P. H.; and Sefcik, S. E.. “Earnings Management, Stock Issues, and Shareholder Lawsuits.” Journal of Financial Economics, 71 (2004), 2749.CrossRefGoogle Scholar
Erickson, M., and Wang, S.-W.. “Earnings Management by Acquiring Firms in Stock for Stock Mergers.” Journal of Accounting and Economics, 27 (1999), 149176.CrossRefGoogle Scholar
Jones, J. J. “Earnings Management during Import Relief Investigations.” Journal of Accounting Research, 29 (1991), 193228.CrossRefGoogle Scholar
Kisgen, D. J. “Do Firms Target Credit Ratings or Leverage Levels?Journal of Financial and Quantitative Analysis, 44 (2009), 13231344.CrossRefGoogle Scholar
Klein, A.Audit Committee, Board of Director Characteristics, and Earnings Management.” Journal of Accounting and Economics, 33 (2002), 375400.CrossRefGoogle Scholar
Loughran, T., and Ritter, J. R.. “The Operating Performance of Firms Conducting Seasoned Equity Offerings.” Journal of Finance, 52 (1997), 18231850.CrossRefGoogle Scholar
Rangan, S.Earnings Management and the Performance of Seasoned Equity Offerings.” Journal of Financial Economics, 50 (1998), 101122.CrossRefGoogle Scholar
Standard & Poor’s. Corporate Ratings Criteria 2006, Standard & Poor’s Inc. (2005) http://www2.standardandpoors.com/spf/pdf/fixedincome/corporateratings_2006.pdf.Google Scholar
Stein, J. C. “Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior.” Quarterly Journal of Economics, 104 (1989), 655669.CrossRefGoogle Scholar
Teoh, S. H.; Welch, I.; and Wong, T. J.. “Earnings Management and the Long-Run Market Performance of Initial Public Offerings.” Journal of Finance, 53 (1998a), 19351974.CrossRefGoogle Scholar
Teoh, S. H.; Welch, I.; and Wong, T. J.. “Earnings Management and the Underperformance of Seasoned Equity Offerings.” Journal of Financial Economics, 50 (1998b), 6399.CrossRefGoogle Scholar
White, H.A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity.” Econometrica, 48 (1980), 817838.CrossRefGoogle Scholar