The Relationship between Earnings Management and Equity Market Timing
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Matheus da Costa Gomes
João Paulo Augusto Eça
Marcelo Botelho da Costa Moraes
MaurÃcio Ribeiro do Valle
Abstract
Objective: this study aims to verify if companies that practice equity market timing have higher earnings management levels around the stock issue period. Method: we used a sample of 68 seasoned equity offerings (SEOs) in Brazil from 2004-2015. First, we ranked the sample among companies that used market timing (timers) behavior in the SEOs and those that did not (non-timers). Second, we estimated each company’s earnings management levels by the Modified Jones and Modified Jones with ROA models. Finally, we tested the relationship between earnings management and equity market timing using a linear regression model. Results: the results show that the timers managed earnings more intensively in the quarters around SEOs than the non-timers. This happens to increase net income and consequently improve profitability ratios. Therefore, to explore opportunity windows, managers can inflate accounting profit through accruals and influence the market’s ability to correctly price shares. Conclusion: Brazilian companies practice earnings management as a way of exploiting opportunity windows in the stock market. The conclusion reinforces the need for a careful analysis of the company’s profits by investors, analysts, auditors, and regulators while allowing efforts to avoid such practices through compliance, governance, and regulation.
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Gomes, M. da C., Eça, J. P. A., Moraes, M. B. da C., & Valle, M. R. do. (2021). The Relationship between Earnings Management and Equity Market Timing. Journal of Contemporary Administration, 25(6), e200289. https://doi.org/10.1590/1982-7849rac2021200289.en
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References
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Alti, A. (2006). How persistent is the impact of market timing on capital structure? The Journal of Finance, 61(4), 1681-1710. https://doi.org/10.1111/j.1540-6261.2006.00886.x
Baker, M., & Wurgler, J. (2000). The equity shares in new issues and aggregate stock returns. The Journal of Finance, 55(5), 2219-2257. https://doi.org/10.1111/0022-1082.00285
Baker, M., & Wurgler, J. (2002). Market timing and capital structure. The Journal of Finance, 57(1), 1-32. https://doi.org/10.1111/1540-6261.00414
Banker, R. D., Byzalov, D., Fang, S., & Jin, B. (2020). Operating asymmetries and non-linear spline correction in discretionary accrual models. Review of Quantitative Finance and Accounting, 54, 803–850. https://doi.org/10.1007/s11156-019-00808-5
Beckmann, K. S., Escobari, D. A., & Ngo, T. (2019). The real earnings management of cross-listing firms. Global Finance Journal, 41, 128-145. https://doi.org/10.1016/j.gfj.2019.04.001
Bowen, R. M., Rajgopal, S., & Venkatachalam, M. (2008). Accounting discretion, corporate governance, and firm performance. Contemporary Accounting Research, 25(2), 351–405. https://doi.org/10.1506/car.25.2.3
Cahan, S. F. (1992). The effect of antitrust investigations on discretionary accruals: A refined test of the political-cost hypothesis. The Accounting Review, 67(1), 77-95. Retrieved from http://www.jstor.org/stable/248021
Cai, J., & Liu, H. (2006). Market timing theory and capital structure in China. Economic Science, 4, 59-69.
Chen, D., Qi, X., Shen, Y., & Lin, H. (2011). Timing earnings. China Journal of Accounting Research, 4(4), 211-232. https://doi.org/10.1016/j.cjar.2011.10.001
DeAngelo, L. E. (1986). Accounting numbers as market valuation substitute: A study of management buyouts of public stockholders. The Accounting Review, 61(3), 400-420. Retrieved from https://www.jstor.org/stable/247149
Dechow, P., & Skinner, D. (2000). Earnings management: Reconciling the views of accounting academics, practitioners, and regulators. Accounting Horizons, 14(2), 235-250. https://doi.org/10.2308/acch.2000.14.2.235
Dechow, P., Sloan, R., & Sweeney, A. (1995). Detecting earnings management. The Accounting Review, 70(2), 193-225. https://www.jstor.org/stable/248303
Dittmar, A., & Field, L. C. (2015). Can managers time the market? Evidence using repurchase price data. Journal of Financial Economics, 115(2), 261-282. https://doi.org/10.1016/j.jfineco.2014.09.007
Domingos, S. R. M., Ponte, V. M. R., Paulo, E., & Alencar, R. C. (2017). Gerenciamento de resultados contábeis em oferta pública de ações. Revista Contemporânea de Contabilidade, 14(31), 89-107. https://doi.org/10.5007/2175-8069.2017v14n31p89
Du, K. (2019). Investor expectations, earnings management, and asset prices. Journal of Economic Dynamics and Control, 105, 134-157. https://doi.org/10.1016/j.jedc.2019.06.002
Gioielli, S. P. O., Carvalho, A. G., & Sampaio, J. O. (2013). Venture capital and earnings management in IPOs. Brazilian Business Review, 10(4), 30-64. https://doi.org/10.15728/bbr.2013.10.4.2
Gomes, M. C., Magnani, V. M., Albanez, T., & Valle, M. R. (2019). Effects of market timing on the primary share issues in the Brazilian capital market. The North American Journal of Economics and Finance, 49, 361-377. https://doi.org/10.1016/j.najef.2019.03.022
Guru, B. K., & Yadav, I. S. (2019). Financial development and economic growth: Panel evidence from BRICS. Journal of Economics, Finance and Administrative Science, 24(47), 113-126. https://doi.org/10.1108/jefas-12-2017-0125
Healy, P. M. (1985). The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics, 7(1-3), 85-107. https://doi.org/10.1016/0165-4101(85)90029-1
Healy, P. M., & Palepu, K. G. (1990). Effectiveness of accounting-based dividend covenants. Journal of Accounting and Economics, 12(1-3), 97–123. https://doi.org/10.1016/0165-4101(90)90043-4
Healy, P. M., & Wahlen, J. M. (1999). A review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13(4), 365-383. https://doi.org/10.2308/acch.1999.13.4.365
Huang, Y., Uchida, K., & Zha, D. (2016). Market timing of season equity offerings with long regulative process. Journal of Corporate Finance, 39(1), 278-294. https://doi.org/10.1016/j.jcorpfin.2016.05.001
Ikenberry, D., Lakonishok, J., & Vermaelen, T. (1995). Market underreaction to open market share repurchases. Journal of Financial Economics, 39(2-3), 181-208. https://doi.org/10.1016/0304-405X(95)00826-Z
Jones, J. J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29(2), 193-228. https://doi.org/10.2307/2491047
Kang, S.-H., & Sivaramakrishnan, K. (1995). Issues in testing earnings management and an instrumental variable approach. Journal of Accounting Research, 33(2), 353-367. https://doi.org/10.2307/2491492
Key, K. G. (1997). Political cost incentives for earnings management in the cable television industry. Journal of Accounting and Economics, 23(3), 309–337. https://doi.org/10.1016/s0165-4101(97)00012-8
Korajczyk, R. A., Lucas, D. J., & McDonald, R. L. (1991). The effects of information releases on the pricing and timing of equity issues. The Review of Financial Studies, 4(4), 685-708. Retrieved from https://www.jstor.org/stable/2962154
Kothari, S. P., Leone, A. J., & Wasley C. E. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39(1), 163-197. https://doi.org/10.1016/j.jacceco.2004.11.002
Liu, J., Uchida, K., & Gao, R. (2014). Earnings management of initial public offering firms: Evidence from regulation changes in China. Accounting & Finance, 54(2), 505-537. https://doi.org/10.1111/acfi.12006
Loughran, T., & Ritter, J. R. (1995). The new issues puzzle. The Journal of Finance, 50(1), 23-51. https://doi.org/10.1111/j.1540-6261.1995.tb05166.x
Maatougui, A. J., & Halioui, K. (2019). The effect of outside blockholders on earnings management around seasoned equity offerings in French listed companies on the SBF120. Journal of Financial Reporting and Accounting, 17(3), 449–467. https://doi.org/10.1108/jfra-02-2018-0012
Marsh, P. (1982). The choice between equity and debt: An empirical study. The Journal of Finance, 37(1), 121-144. https://doi.org/10.2307/2327121
Paulo, E. (2007). Manipulation of accounting information: A theoretical and empirical analysis on the operational models of earnings management detection (Doctoral dissertation) Universidade de São Paulo, São Paulo, Brazil. https://doi.org/10.11606/T.12.2007.tde-28012008-113439
Premti, A., & Smith, G. (2020). Earnings management in the pre-IPO process: Biases and predictors. Research in International Business and Finance, 52, 101120. https://doi.org/10.1016/j.ribaf.2019.101120
Rajan, R., & Servaes, H. (1997). Analyst following of initial public offerings. The Journal of Finance, 52(2), 507-529. https://doi.org/10.1111/j.1540-6261.1997.tb04811.x
Rangan, S. (1998). Earnings management and the performance of seasoned equity offerings. Journal of Financial Economics, 50(1), 101-122. https://doi.org/10.1016/S0304-405X(98)00033-6
Ritter, J. R. (1991). The long-run performance of initial public offerings. The Journal of Finance, 46(1), 3-27. https://doi.org/10.1111/j.1540-6261.1991.tb03743.x
Ritter, J. R. (2003). Investment banking and securities issuance. In G. M Constantinides, M. Harris, & R. Stulz (Eds.), Handbook of the Economics of Finance (pp. 255-306), Amsterdam: North Holland.
Ross, S. A., Westerfield, R. W., & Jaffe, J. (2013). Corporate Finance (10th ed.). New York: The McGraw-Hill.
Rossi Junior, J. L., & Marotta, M. (2010). Equity market timing: Testando através de IPO no mercado brasileiro. Revista Brasileira de Finanças, 8, 85-101. Retrieved from http://www.spell.org.br/documentos/ver/4506/equity-market-timing--testando-atraves-dos-ipos-no-mercado-brasileiro/i/pt-br
Santana, C. V. S., Santos, L. P. G., Carvalho Júnior, C. V. O., & Martinez, A. L. (2020). Investor sentiment and earnings management in Brazil. Revista Contabilidade & Finanças, 31(83), 283-301. https://doi.org/10.1590/1808-057x201909130
Scott, W. R. (2003). Financial accounting theory (3rd. ed). Toronto: Prentice Hall.
Silva, J. M. A., & Famá, R. (2011). Evidências de retornos anormais nos processos de IPO na Bovespa no perÃodo de 2004 a 2007: Um estudo de evento. Revista de Administração, 46(2), 178-190. https://doi.org/10.5700/rausp1006
Sincerre, B. P., Sampaio, J. O., Famá, R, & Santos, J. O. (2016). Debt issues and earnings management. Revista Contabilidade & Finanças, 27(72), 291-305. https://doi.org/10.1590/1808-057x201601660
Sweeney, A. P. (1994). Debt-covenant violations and managers’ accounting responses. Journal of Accounting and Economics, 17(3), 281–308. https://doi.org/10.1016/0165-4101(94)90030-2
Taggart Jr., R. A. (1977). A model of corporate financing decisions. The Journal of Finance, 32(5), 1467-1484. https://doi.org/10.2307/2326804
Wooldridge, J. M. (2010). Econometric analysis of cross section and panel data (2nd ed). Cambridge, MA: MIT Press.
Yu, K., Hagigi, M., & Stewart, S. D. (2018). Income smoothing may result in increased perceived riskiness: Evidence from bid-ask spreads around loss announcements. Journal of Corporate Finance, 48, 442–459. https://doi.org/10.1016/j.jcorpfin.2017.11.007
Yung, K., & Root, A. (2019). Policy uncertainty and earnings management: International evidence. Journal of Business Research, 100, 255–267. https://doi.org/10.1016/j.jbusres.2019.03.058
Albanez, T., & Lima, G. A. S. F. (2014). Effects of market timing on the capital structure of Brazilian firms. International Finance Review, 15, 307-351. https://doi.org/10.1108/S1569-376720140000015013
Alti, A. (2006). How persistent is the impact of market timing on capital structure? The Journal of Finance, 61(4), 1681-1710. https://doi.org/10.1111/j.1540-6261.2006.00886.x
Baker, M., & Wurgler, J. (2000). The equity shares in new issues and aggregate stock returns. The Journal of Finance, 55(5), 2219-2257. https://doi.org/10.1111/0022-1082.00285
Baker, M., & Wurgler, J. (2002). Market timing and capital structure. The Journal of Finance, 57(1), 1-32. https://doi.org/10.1111/1540-6261.00414
Banker, R. D., Byzalov, D., Fang, S., & Jin, B. (2020). Operating asymmetries and non-linear spline correction in discretionary accrual models. Review of Quantitative Finance and Accounting, 54, 803–850. https://doi.org/10.1007/s11156-019-00808-5
Beckmann, K. S., Escobari, D. A., & Ngo, T. (2019). The real earnings management of cross-listing firms. Global Finance Journal, 41, 128-145. https://doi.org/10.1016/j.gfj.2019.04.001
Bowen, R. M., Rajgopal, S., & Venkatachalam, M. (2008). Accounting discretion, corporate governance, and firm performance. Contemporary Accounting Research, 25(2), 351–405. https://doi.org/10.1506/car.25.2.3
Cahan, S. F. (1992). The effect of antitrust investigations on discretionary accruals: A refined test of the political-cost hypothesis. The Accounting Review, 67(1), 77-95. Retrieved from http://www.jstor.org/stable/248021
Cai, J., & Liu, H. (2006). Market timing theory and capital structure in China. Economic Science, 4, 59-69.
Chen, D., Qi, X., Shen, Y., & Lin, H. (2011). Timing earnings. China Journal of Accounting Research, 4(4), 211-232. https://doi.org/10.1016/j.cjar.2011.10.001
DeAngelo, L. E. (1986). Accounting numbers as market valuation substitute: A study of management buyouts of public stockholders. The Accounting Review, 61(3), 400-420. Retrieved from https://www.jstor.org/stable/247149
Dechow, P., & Skinner, D. (2000). Earnings management: Reconciling the views of accounting academics, practitioners, and regulators. Accounting Horizons, 14(2), 235-250. https://doi.org/10.2308/acch.2000.14.2.235
Dechow, P., Sloan, R., & Sweeney, A. (1995). Detecting earnings management. The Accounting Review, 70(2), 193-225. https://www.jstor.org/stable/248303
Dittmar, A., & Field, L. C. (2015). Can managers time the market? Evidence using repurchase price data. Journal of Financial Economics, 115(2), 261-282. https://doi.org/10.1016/j.jfineco.2014.09.007
Domingos, S. R. M., Ponte, V. M. R., Paulo, E., & Alencar, R. C. (2017). Gerenciamento de resultados contábeis em oferta pública de ações. Revista Contemporânea de Contabilidade, 14(31), 89-107. https://doi.org/10.5007/2175-8069.2017v14n31p89
Du, K. (2019). Investor expectations, earnings management, and asset prices. Journal of Economic Dynamics and Control, 105, 134-157. https://doi.org/10.1016/j.jedc.2019.06.002
Gioielli, S. P. O., Carvalho, A. G., & Sampaio, J. O. (2013). Venture capital and earnings management in IPOs. Brazilian Business Review, 10(4), 30-64. https://doi.org/10.15728/bbr.2013.10.4.2
Gomes, M. C., Magnani, V. M., Albanez, T., & Valle, M. R. (2019). Effects of market timing on the primary share issues in the Brazilian capital market. The North American Journal of Economics and Finance, 49, 361-377. https://doi.org/10.1016/j.najef.2019.03.022
Guru, B. K., & Yadav, I. S. (2019). Financial development and economic growth: Panel evidence from BRICS. Journal of Economics, Finance and Administrative Science, 24(47), 113-126. https://doi.org/10.1108/jefas-12-2017-0125
Healy, P. M. (1985). The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics, 7(1-3), 85-107. https://doi.org/10.1016/0165-4101(85)90029-1
Healy, P. M., & Palepu, K. G. (1990). Effectiveness of accounting-based dividend covenants. Journal of Accounting and Economics, 12(1-3), 97–123. https://doi.org/10.1016/0165-4101(90)90043-4
Healy, P. M., & Wahlen, J. M. (1999). A review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13(4), 365-383. https://doi.org/10.2308/acch.1999.13.4.365
Huang, Y., Uchida, K., & Zha, D. (2016). Market timing of season equity offerings with long regulative process. Journal of Corporate Finance, 39(1), 278-294. https://doi.org/10.1016/j.jcorpfin.2016.05.001
Ikenberry, D., Lakonishok, J., & Vermaelen, T. (1995). Market underreaction to open market share repurchases. Journal of Financial Economics, 39(2-3), 181-208. https://doi.org/10.1016/0304-405X(95)00826-Z
Jones, J. J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29(2), 193-228. https://doi.org/10.2307/2491047
Kang, S.-H., & Sivaramakrishnan, K. (1995). Issues in testing earnings management and an instrumental variable approach. Journal of Accounting Research, 33(2), 353-367. https://doi.org/10.2307/2491492
Key, K. G. (1997). Political cost incentives for earnings management in the cable television industry. Journal of Accounting and Economics, 23(3), 309–337. https://doi.org/10.1016/s0165-4101(97)00012-8
Korajczyk, R. A., Lucas, D. J., & McDonald, R. L. (1991). The effects of information releases on the pricing and timing of equity issues. The Review of Financial Studies, 4(4), 685-708. Retrieved from https://www.jstor.org/stable/2962154
Kothari, S. P., Leone, A. J., & Wasley C. E. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39(1), 163-197. https://doi.org/10.1016/j.jacceco.2004.11.002
Liu, J., Uchida, K., & Gao, R. (2014). Earnings management of initial public offering firms: Evidence from regulation changes in China. Accounting & Finance, 54(2), 505-537. https://doi.org/10.1111/acfi.12006
Loughran, T., & Ritter, J. R. (1995). The new issues puzzle. The Journal of Finance, 50(1), 23-51. https://doi.org/10.1111/j.1540-6261.1995.tb05166.x
Maatougui, A. J., & Halioui, K. (2019). The effect of outside blockholders on earnings management around seasoned equity offerings in French listed companies on the SBF120. Journal of Financial Reporting and Accounting, 17(3), 449–467. https://doi.org/10.1108/jfra-02-2018-0012
Marsh, P. (1982). The choice between equity and debt: An empirical study. The Journal of Finance, 37(1), 121-144. https://doi.org/10.2307/2327121
Paulo, E. (2007). Manipulation of accounting information: A theoretical and empirical analysis on the operational models of earnings management detection (Doctoral dissertation) Universidade de São Paulo, São Paulo, Brazil. https://doi.org/10.11606/T.12.2007.tde-28012008-113439
Premti, A., & Smith, G. (2020). Earnings management in the pre-IPO process: Biases and predictors. Research in International Business and Finance, 52, 101120. https://doi.org/10.1016/j.ribaf.2019.101120
Rajan, R., & Servaes, H. (1997). Analyst following of initial public offerings. The Journal of Finance, 52(2), 507-529. https://doi.org/10.1111/j.1540-6261.1997.tb04811.x
Rangan, S. (1998). Earnings management and the performance of seasoned equity offerings. Journal of Financial Economics, 50(1), 101-122. https://doi.org/10.1016/S0304-405X(98)00033-6
Ritter, J. R. (1991). The long-run performance of initial public offerings. The Journal of Finance, 46(1), 3-27. https://doi.org/10.1111/j.1540-6261.1991.tb03743.x
Ritter, J. R. (2003). Investment banking and securities issuance. In G. M Constantinides, M. Harris, & R. Stulz (Eds.), Handbook of the Economics of Finance (pp. 255-306), Amsterdam: North Holland.
Ross, S. A., Westerfield, R. W., & Jaffe, J. (2013). Corporate Finance (10th ed.). New York: The McGraw-Hill.
Rossi Junior, J. L., & Marotta, M. (2010). Equity market timing: Testando através de IPO no mercado brasileiro. Revista Brasileira de Finanças, 8, 85-101. Retrieved from http://www.spell.org.br/documentos/ver/4506/equity-market-timing--testando-atraves-dos-ipos-no-mercado-brasileiro/i/pt-br
Santana, C. V. S., Santos, L. P. G., Carvalho Júnior, C. V. O., & Martinez, A. L. (2020). Investor sentiment and earnings management in Brazil. Revista Contabilidade & Finanças, 31(83), 283-301. https://doi.org/10.1590/1808-057x201909130
Scott, W. R. (2003). Financial accounting theory (3rd. ed). Toronto: Prentice Hall.
Silva, J. M. A., & Famá, R. (2011). Evidências de retornos anormais nos processos de IPO na Bovespa no perÃodo de 2004 a 2007: Um estudo de evento. Revista de Administração, 46(2), 178-190. https://doi.org/10.5700/rausp1006
Sincerre, B. P., Sampaio, J. O., Famá, R, & Santos, J. O. (2016). Debt issues and earnings management. Revista Contabilidade & Finanças, 27(72), 291-305. https://doi.org/10.1590/1808-057x201601660
Sweeney, A. P. (1994). Debt-covenant violations and managers’ accounting responses. Journal of Accounting and Economics, 17(3), 281–308. https://doi.org/10.1016/0165-4101(94)90030-2
Taggart Jr., R. A. (1977). A model of corporate financing decisions. The Journal of Finance, 32(5), 1467-1484. https://doi.org/10.2307/2326804
Wooldridge, J. M. (2010). Econometric analysis of cross section and panel data (2nd ed). Cambridge, MA: MIT Press.
Yu, K., Hagigi, M., & Stewart, S. D. (2018). Income smoothing may result in increased perceived riskiness: Evidence from bid-ask spreads around loss announcements. Journal of Corporate Finance, 48, 442–459. https://doi.org/10.1016/j.jcorpfin.2017.11.007
Yung, K., & Root, A. (2019). Policy uncertainty and earnings management: International evidence. Journal of Business Research, 100, 255–267. https://doi.org/10.1016/j.jbusres.2019.03.058