The Choice between Real and Accrual-Based Earnings Management Around Initial Public Offerings and its Legal Consequences

Abstract

Prior research suggests that managers of firms manipulate earnings through accruals to achieve certain reporting and personal objectives such as meeting specific benchmarks; Recently, researchers have turned their attention to real manipulation as an alternative to accrual manipulation e.g. through eliminating advertising expenditures or research and development expenditures. However, there is no evidence on whether the likelihood of being detected by outsiders, specifically investors, and ultimately sued is different for firms using these different methods to manage earnings. In this study, we examine this research question in the context of equity offerings. This context has been used in prior research considering earnings management. In particular, this study addresses the following questions. First, what methods are used by firms to manipulate earnings around equity offerings, and second, whether the likelihood of litigation varies with the method(s) used to reach earnings goals around these stock issues.