Do Syndicated Loan Borrowers Trade-Off Accrual-Based Earnings Management with Real Activities Manipulation?

Abstract

Following the studies of Ahn and Choi (2009) and Cohen and Zarowin (2010), we examine the tradeoff between alternative earnings management mechanisms among syndicated loan borrowers. The syndicated loan market bridges the private and public fixed-income markets and provides borrowers with an alternative to high yield bonds and illiquid bilateral commercial bank loans. It provides much-needed credit to borrowers, yet we know little about the earnings management tradeoffs — especially among syndicate borrowers. Using a propensity score matched sample between 1988 and 2006, we find evidence of downward discretionary accruals and a negative abnormal cash flow from operations around the origination of syndicated loans. We predict that while syndicated loan borrowers are likely to manipulate accounting earnings, they draw more heavily on accrual-based earnings management (AEM) than on Real Activities Manipulation (RAM). Our results show income decreasing discretionary accruals and negative abnormal cash flow from operations around syndicated loan origination. Further analysis suggests that syndicate lenders’ monitoring mechanisms — such as reputable lenders, number of syndication, loan size and loan maturity — are significantly associated with the documented earnings management practices. Additionally, the observed income decreasing discretionary accruals and negative abnormal cash flow from operations are negatively associated with the cost of debt.