Earnings Management and Stock Performance of Reverse Leveraged Buyouts

Abstract

This study provides further evidence of earnings management around security offerings. We find positive and significant discretionary current accruals coincident with offerings of reverse LBOs. Issuers in the most aggressive quartile of earnings management have a one-year aftermarket return that is between 15% and 25% less than the most conservative quartile. We also find a negative and significant relation between abnormal accruals and post-issue abnormal returns within the first year after the offering. The relation remains after controlling for book-to-market ratio, firm size, offering size, and involvement of buyout specialists or management. Although earnings management has been used to explain post-issue long-term underperformance of IPOs and SEOs, our study shows that earnings management can explain post-offering returns of reverse LBOs, even in the absence of post-offering underperformance.

Reverse Leveraged Buyout Return Behavior: Some European Evidence

“…Degeorge and Zeckhauser (1993) claim that it is possible for managers to manipulate the reported operating performance of the company before the IPO -for instance, by borrowing on the past or future. Chou et al (2006) investigate this hypothesis by looking at earnings management around the RLBO initial public offering. The authors compute abnormal discretionary current accruals.…”

“…These results are consistent with Teoh et al (1998aTeoh et al ( , 1998b, who find earnings management around the offering period and a negative relation between the management earnings level and the stock underperformance after the company goes public. Chou et al (2006) investigate the potential causes of earnings management around the offering of the RLBO. They report that earnings management in RLBOs results from information asymmetry between buyers and sellers during the IPO, but to a lesser extent than in classic IPOs.…”

“…The existence of earnings management in RLBOs may be reinforced by the presence of institutional investors and LBO specialists as they may have some interest in earnings management too. Chou et al (2006) divide their sample into quartiles based on the level of managed earnings. They find that the most aggressive quartiles experience lower stock returns than the most conservative ones in the year following the offering.…”

“…As for the stock performance, Holthausen and Larcker (1996) find that it is either positive or close to zero depending on the chosen observation period. Chou et al (2006) investigate asymmetric information issues in RLBOs, and, more particularly, earnings management during the RLBO pre-offering period. Degeorge and Zeckhauser (1993) show that it is possible for managers to manipulate the reported operating performance of the company before the IPO (through the reduction of investment or R&D costs for example).…”

The advantages of using quarterly returns for long-term event studies

“…We refer to those firms that have made information announcements as event or treatment firms and those firms selected for comparison as match [matching] or control firms and to this category of techniques as characteristic-based matching. As pointed out by Chou et al (2006Chou et al ( , 2010, Dichev and Piotroski (2001), Ang and Zhang (2004) and Byoun (2004) there is a lack of consensus on the best approach to select the comparison firm returns and to ascertain whether the abnormal returns generated using a particular firm or set of firms are statistically detectible at generally accepted levels. 3 In this paper, we propose and investigate tests for abnormal returns on quarterly nonoverlapping intervals that can be used for longer periods (up to 2 years) alone or in conjunction with the current long-term tests.…”