Earnings Accruals and Real Activities Management around Initial Public Offerings

Transcription

1 Earnings Accruals and Real Activities Management around Initial Public Offerings

2 Peter Ising Earnings Accruals and Real Activities Management around Initial Public Offerings Evidence from Specific Industries

3 Peter Ising Zurich, Switzerland Dissertation University of Zurich, 2013 ISBN DOI / ISBN (ebook) The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data are available in the Internet at Library of Congress Control Number: Springer Gabler Springer Fachmedien Wiesbaden 2014 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. Exempted from this legal reservation are brief excerpts in connection with reviews or scholarly analysis or material supplied specifically for the purpose of being entered and executed on a computer system, for exclusive use by the purchaser of the work. Duplication of this publication or parts thereof is permitted only under the provisions of the Copyright Law of the Publisher s location, in its current version, and permission for use must always be obtained from Springer. Permissions for use may be obtained through RightsLink at the Copyright Clearance Center. Violations are liable to prosecution under the respective Copyright Law. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. While the advice and information in this book are believed to be true and accurate at the date of publication, neither the authors nor the editors nor the publisher can accept any legal responsibility for any errors or omissions that may be made. The publisher makes no warranty, express or implied, with respect to the material contained herein. Printed on acid-free paper Springer Gabler is a brand of Springer DE. Springer DE is part of Springer Science+Business Media.

4 To my family

5 Foreword VII Foreword The present book by Peter Ising ties in with research in the area of earnings management. The procedural method consists of analyzing initial public offerings which are expected to have a high probability for strong incentives to use discretionary behavior. The author derives hypotheses for the US capital market and conducts tests with capacious data. The first group of hypotheses primarily tests if discretionary reporting during initial public offerings exists. To uncover real activities management, the dissertation includes several accounting items as well as the typically employed accruals. The outcome of the thesis demonstrates that real activities management before and after going public in the US exists. Current literature differs about the existence of accruals management. To shed light on these diverging results, the author takes several dimensions into account. On the one hand, he differentiates between points in time around the IPO and on the other hand between industries. Both issues are not covered sufficiently, yet. Findings show that a differentiation between both subjects can have a substantial influence on results. Furthermore, the thesis includes a separation between profitable and unprofitable companies. This distinction is rarely used in prior literature, but results show interesting implications for research and practice, because plenty of companies in certain industries are unprofitable around the IPO. The second group of hypotheses focusses primarily on differences between specific accounting items in certain industries. Especially the finance literature examined differences in financial ratios for firms around the IPO. The presented revelation that growth industries use expense accounts to a larger extent than established industries around issuing stock to influence investors supports practitioners in analyzing companies. While prior literature mainly expected the reduction of expenses to increase income, the author evidences abnormal increases in growth industries. The results are a valuable source against the background that growth companies are evaluated by their future prospects. To conclude, the multi-dimensional approach which combines several research components must be highlighted because it is challenging and gives interesting insights. The selected research questions refer not only to open issues in research, but also offer valuable and detailed guidance for practitioners. I recommend this thesis to researchers and professionals, and wish that it wins the broad readership it deserves. Prof. Dr. Dieter Pfaff

6 Acknowledgment IX Acknowledgment This dissertation is the result of my doctoral studies in Zurich, Switzerland. The time during these years was insightful and enriching. I would like to thank everyone who supported me and made my time at the University of Zurich such a unique experience. First, I express my gratitude to the supervisor of my dissertation and my academic mentor, Prof. Dr. Dieter Pfaff. During my employment at his Chair of Accounting he was available at all times for arising questions and continuously supported the dissertation. Moreover, he advocated extra-curricular activities such as my IFRS-Accountant diploma or the teaching assignment at the Controller Academy. Especially, I thank him for the academic freedom to pursue my favorite topic at the crossroads of accounting and capital markets. I also thank Prof. Dr. Conrad Meyer for being my second supervisor. There are many people who have made the dissertation and the work as a researcher a pleasant experience. My thanks go to all my doctoral colleagues, administrative assistants, and friends at the several chairs of business administration for academic and leisure time collaboration. In the course of developing my dissertation I benefitted from the interaction with numerous practitioners and scholars at conferences in Harvard, London, Amsterdam, Prague, WHU Vallendar, and Zurich. Due to the financial support of several scholarships from the Graduate School of Business, I was able to attend these valuable events. Most importantly, my education and this dissertation would not have been possible without the support of my family. My deepest gratitude goes to my parents. My father Dr. Achim Ising and my mother Heidi Ising encouraged me to follow my interests, gave me guidance, and pointed out how to proceed in life. I very much appreciate the support by my brother Dr. Alexander Ising at every stage in my life. Furthermore, I owe gratitude to Meike for continuous moral encouragement and advice. Many thanks to all for supporting my work! Peter Ising

7 Table of Contents XI Table of Contents Table of Contents... XI List of Abbreviations and Symbols... XVII List of Figures...XXI List of Tables...XXIII 1. Introduction Motivation Objective Initial Public Offerings Process of an IPO Motivations for Going Public Industry Differences Discretionary Reporting Definition Earnings Accruals and Real Activities Management Earnings Accruals Management Real Activity Management Overview Sales CfO R&D SG&A Advertising Discretionary Expenses Change in Inventory COGS Production GAS IPO Specifics Agents and Motivation Discretionary Reporting Time Inflation vs. Deflation Literature Overview State of Research Earnings Accruals Management... 31

8 XII Table of Contents Teoh et al. (1998b) Ball/Shivakumar (2008) Real Activities Management Roychowdhury (2006) Gunny (2010) Multi-Dimensional Approaches Cohen/Zarowin (2010) Fedyk et al. (2012) Hypotheses and Models Hypotheses Development Research Aspects Hypotheses for Periods around IPO Distinction between Years Specifics of Sales and CfO Hypothesis Sales Hypothesis Cash Flow Hypotheses for Specific Industries High-Growth vs. Well-Established Industries Profitable vs. Unprofitable Industries Econometric Models General Accruals and Real Activity Models Earnings Accruals Models Sales Models Specific Real Activity Models Research Design Empirical Study Sample and Data Descriptive Statistics Empirical Results Results for Periods around IPO Hypothesis Earnings Accruals Biotech Internet Technology Construction Wholesale Hypotheses Sales 1 and Biotech... 87

9 Table of Contents XIII Internet Technology Construction Wholesale Hypothesis Sales Hypotheses CfO 1 and Biotech Internet Technology Construction Wholesale Hypothesis CfO Hypothesis R&D Biotech Internet Technology Construction Wholesale Hypothesis SG&A Biotech Internet Technology Construction Wholesale Hypothesis Advertising Biotech Internet Technology Construction Wholesale Hypothesis Discretionary Expenses Biotech Internet Technology Construction Wholesale Hypothesis Change in Inventory Biotech Internet

10 XIV Table of Contents Technology Construction Wholesale Hypothesis COGS Biotech Internet Technology Construction Wholesale Hypothesis Production Biotech Internet Technology Construction Wholesale Hypothesis GAS Biotech Internet Technology Construction Wholesale Results for Specific Industries High-Growth vs. Well-Established Industries Hypothesis R&D Hypothesis SG&A Hypothesis Advertising Hypothesis Discretionary Expenses Profitable vs. Unprofitable Industries Hypothesis Earnings Accruals Hypothesis Earnings Accruals Summary of Results Robustness Analyses Tests for Regression Assumptions Further Models Model Development Earnings Accruals Models Sales Model Various Real Activity Models Results for Periods around IPO

11 Table of Contents XV Earnings Accruals Sales R&D SG&A Advertising Expenses Discretionary Expenses Change in Inventory Production Costs Results for Specific Industries High-Growth vs. Well-Established Industries Profitable vs. Unprofitable Industries Conclusion Summary Limitations Research Perspectives Appendix References

12 List of Abbreviations and Symbols XVII List of Abbreviations and Symbols # i'!. A Me adj. R' ADR AM ASales AvChe BV CEO CII) CFO COGS CRSP D.i'!.DefRev D.i'!.GrRec D.i'!.Inv D.i'!.Rec D.Me D.Adv D.CII) D.COGS D.DisExp D.GAS D.Prod D.R&D D.SGA DS e.g. Ed. Eds. eta!. number/amount change total assets accruals adjusted R-squared American depository receipts accruals-based earnings management long-lived asset sales average cash book value chief executive officer cash flow from operating activities chief financial officer cost of goods sold Center fur Research in Security Prices discretionary change in deferred revenues discretionary change in gross receivables discretionary change in inventory discretionary change in receivables discretionary accruals discretionary advertising expenses discretionary cash flow from operations discretionary costs of goods sold abnormal discretionary expenses discretionary gain on asset sales discretionary production costs discretionary research and development expenses discretionary selling, general, and administrative expenses domestic accounting standard fur example (exempli gratia) editor editors et alii, et aliae

13 XVIII List of Abbreviations and Symbols etc. et cetera FASB Financial Accounting Standards Board FIFO first in first out GAAP generally accepted accounting principles GAS gain on asset sales GrRec gross accounts receivable IAS International Accounting Standards IFRS International Financial Reporting Standards Int. A intangible assets IntFu internal funds IPO initial public offering ISales long-lived investment sales LIFO last in first out M&A merger & acquisition MV market value N number NegD.Acc negative discretionary accruals no. number No. number(s) Non-C. A non-cash assets NYSE New York Stock Exchange OLS ordinary least squares p. page PosD.Acc positive discretionary accruals PPE property, plant, and equipment prof. profitable profit. profitable R&D research and development expenses RAM real activities management RD research and development expenses Rec net account receivables REIT real estate investment trust RESET regression specification-error test ROA return on assets

14 List of Abbreviations and Symbols XIX S SalesGR SEO SFAS SG&A SIC TAcc UCLA VIF vs. WRDS sales growth of sales seasoned equity offering Statements of Financial Accounting Standards selling, general, and administrative Standard Industry Classification total accruals University of California, Los Angeles variance inflation factor versus Wharton Research Data Services

15 List of Figures XXI List of Figures Figure 1: Time Line of IPO Years...6 Figure 2: Types of Discretionary Reporting Figure 3: Overview of Hypotheses Set Figure 4: IPOs by Industry and Year Figure 5: Percentage of Profitable Companies around the IPO... 70

16 List of Tables XXIII List of Tables Table 1: Characterization and Examples of Reporting Types Table 2: Industries and Codes Table 3: Number of Firms and Firm-Years by Industry Table 4: IPOs by Industry and Year Table 5: Sample Firms per Year and Percentage of Profitability Table 6: Descriptive Statistics of IPO Companies by Industry Table 7: Pearson Correlation for Discretionary Variables in the Biotech Industry Table 8: Pearson Correlation for Discretionary Variables in the Internet Industry Table 9: Pearson Correlation for Discretionary Variables in the Technology Industry Table 10: Pearson Correlation for Discretionary Variables in the Construction Industry Table 11: Pearson Correlation for Discretionary Variables in the Wholesale Industry Table 12: Earnings Accruals by Year, Group, and Industry Table 13: Discretionary Change in Receivables by Year, Group, and Industry Table 14: Discretionary Change in Gross Receivables by Year, Group, and Industry Table 15: Discretionary Change in Deferred Revenue by Year, Group, and Industry Table 16: Discretionary Cash Flow from Operations by Year, Group, and Industry Table 17: Discretionary R&D by Year, Group, and Industry Table 18: Discretionary SG&A by Year, Group, and Industry Table 19: Discretionary Advertising Expenses by Year, Group, and Industry Table 20: Abnormal Discretionary Expenses by Year, Group, and Industry

17 XXIV List of Tables Table 21: Discretionary Change in Inventory by Year, Group, and Industry Table 22: Discretionary COGS by Year, Group, and Industry Table 23: Discretionary Production Costs by Year, Group, and Industry Table 24: Discretionary Gain on Asset Sales by Year, Group, and Industry Table 25: Summary for Hypotheses Concerning the Growth of Industries Table 26: Discretionary R&D: Industry Comparison Table 27: Discretionary SG&A: Industry Comparison Table 28: Discretionary Advertising: Industry Comparison Table 29: Abnormal Discretionary Expenses: Industry Comparison Table 30: Discretionary Earnings Accruals: Profitable Industries Table 31: Discretionary Earnings Accruals: Unprofitable Industries Table 32: Test of Multicollinearity for the Modified Jones Model