EARNINGS MANAGEMENT AND LONG-RUN STOCK UNDERPERFORMANCE OF PRIVATE PLACEMENTS
business
Description
EARNINGS MANAGEMENT AND LONG-RUN STOCK
UNDERPERFORMANCE OF PRIVATE PLACEMENTS
Daoping He, San Jose State University
David C. Yang, University of Hawaii at Manoa
Liming Guan, University of Hawaii at Manoa
ABSTRACT
The study investigates whether private placement issuers manipulate their earnings around
the time of issuance and the effect of earnings management on the long-run stock performance. We
find that managers of U.S. private placement issuers tend to engage in income-increasing earnings
management in the year prior to the issuance of private placements. We further speculate that
earnings management serves as a likely source of investor over-optimism at the time of private
placements. To support this speculation, we find evidence suggesting that the income-increasing
accounting accruals made at the time of private placements predict the post-issue long-term stock
underperformance. The study contributes to the large body of literature on earnings manipulation
around the time of securities issuance.
INTRODUCTION
This study seeks to accomplish two goals regarding the issuance of seasoned private
placements of common equity (hereafter, private placements): (1) to investigate managers’ earnings
manipulation behavior of U.S. issuers around the time of the issuance; (2) to examine whether such
earnings manipulation behavior helps explain the long-term post-issue stock underperformance.
Private placements, together with seasoned public offerings of common equity (SEO), are
two important vehicles by which public firms obtain equity financing. Contrary to seasoned public
offerings of common equity, which issue new equity to the general public, private placement issuers
sell new equity to a restricted number of investors. More than 30 percent of seasoned equity
financing from external investors in recent years has come from private placements (Federal Reserve
Bulletin, see Appendix A). While there is a sizeable body of literature on earnings management
around the time of seasoned public offerings and on the issuers’ post-issue stock underperformance,
research on these issues related to private placements is scarce.
