Abnormal Accruals in Newly Public Companies: Opportunistic Misreporting or Economic Activity?

Abstract

Newly public companies tend to exhibit abnormally high accruals in the year of their initial public offering (IPO). Although the prevailing view in the literature is that these accruals are caused by opportunistic misreporting, we show that these accruals do not appear to benefit managers and instead result from the normal economic activity of newly public companies. In particular, and in contrast to the notion that managers benefit from inflating accruals through an inflated issue price, inflated post-IPO equity values, and increased insider trading profits, we find no evidence of a relation between abnormal accruals and these outcomes. Instead, consistent with these accruals resulting from normal economic activity, we find that these accruals are attributable to the investment of IPO proceeds in working capital and that controlling for the amount of IPO proceeds invested in working capital produces a more powerful accrual-based measure of misreporting. AbstractThis study investigates the determinants and trading performance of outside directors' equity deferrals, which represent the choice to convert part or all of their annual cash compensation into deferred company stock. Using a large sample of S&P1500 firms that allowed directors to defer their cash fees into equity between 1999 and 2009, we find significant associations between equity deferral choices and specific features of the director compensation plans, proxies for directors' outside wealth diversification, and future firm stock market performance. Trading performance analyses indicate that outside directors earn substantial abnormal returns from their deferrals, with a significant proportion of the deferral transactions occurring during blackout periods. These results are consistent with companies structuring director equity deferral plans to circumvent SEC Rule 10b-5's trading restrictions.Key words: outside directors; deferred compensation; insider trading; SEC Rule 10b-5 plans.a We are grateful to Mary Barth (the department editor), an anonymous associate editor, and three anonymous referees for very constructive comments. We also appreciate helpful suggestions from

Discretionary Accruals: Earnings Management ... or Not?

“…Armstrong et al . () and Owens et al . () are two recent examples of where the economics are explicitly considered and more reasonable results are obtained.…”

Is Window-Dressing around Going Public Beneficial? Evidence from Poland

“…Contrary to that, Ball and Shivakumar (2008) showed that public firms report more conservatively. Armstrong et al (2015) concluded that IPO companies are not systematically opportunistic. Much of the existing literature reports significant long-term IPO underperformance with some studies dissecting the long-term IPO anomaly with an accrual-based explanation for other, mostly developed, markets.…”

Does Manager Ability Influence Prospectus Earnings Quality and IPO Underpricing?

“…Consistent with prior literature we use signed discretionary accrual quality as our measure of accrual quality (Teoh et al, 1998Armstrong et al, 2016). (Note 6) We estimate four measures of accrual quality: (1) discretionary accruals based on the Jones (1991) model; (2) discretionary accruals based on the modified Jones model (Dechow, Sloan, & Sweeney, 1995); (3) discretionary accruals controlling for ROA based on Kothari, Leone, & Wasley (2005); and (4) an aggregate average value of the three individual metrics (Boulton et al, 2011).…”