Earnings Management and Performance of Indian Equity Rights Issues

Abstract

Earnings management occurs when managers use judgment in financial reporting and in structural transactions to alter financial reports to either mislead some stakeholders about the underlying performance of the company, or to influence contractual outcomes that depend on reported financial performance. Many research studies are conducted to investigate the earnings management in developed economies. Due to regulated operating environment of in India until 1992 earnings management was not a fertile topic for research. But, post-1992 companies are given freedom to price their capital issues. This freedom motivates the issuers to manage their earnings prior to capital issues. The objectives of the study are to investigate if firms in India manage earnings prior to launching of equity rights issues (known as seasoned equity offerings in the USA and Europe) and the post issue performance of the firms. We used discretionary current accruals (DCAs) to measure the extent of earnings management. Modified Jones Model is used to estimate DCAs during three years prior to the rights issue (pre-issue period) and three years after the rights issue (post-issue period). DCAs of rights issue firms are adjusted for DCAs of control sample (non-rights issuers).Adjusted mean DCAs of pre-issue period is compared with adjusted mean DCAs of the post-issue period to detect earnings management. The results suggest that there has been earnings management prior to the rights issues. Analysis of pre-and-post issue performance the sample firms corroborate the findings based on DCAs. Study period is 1993-94 to 2003-04. Sample size is 259.