國立臺灣大學管理學院會計學系 碩士論文
Department of Accounting College of Management National Taiwan University
Master Thesis
公司上市櫃前盈餘管理
Earnings management for newly listed firms
于智帆 Yu, Chih-Fan
指導教授：王泰昌 博士
劉嘉雯 博士 Advisors: Wang, Taychang, Ph.D.
Liu, Chiawen, Ph.D.
中華民國 97 年 6 月
June, 2008
謝 謝 謝 謝辭 辭 辭 辭
時間總是在忙碌的時刻快速消逝，轉眼之間就來到了畢業的這一刻，回顧這 一路上的酸甜苦辣，歷歷在目。從徬徨無措的找尋論文題目到怡然自得的寫謝 辭，我深深瞭解論文絕對不是一個人就可以辦到的，在這過程中，要感謝許多老 師、同學、家人的相助，沒有你們就沒有今天的我。
王泰昌教授和劉嘉雯教授是我從大學時代就非常尊敬也非常喜愛的老師，在 他們的課堂上，我學到了什麼叫做認真負責以及邏輯清晰。對我來說，兩位老師 除了授課解惑之外，更曾經多次提供我寶貴意見以及實質的幫助，讓我獲益良 多。在指導論文的過程中，王老師總是可以用精簡的文字一針見血的指出問題所 在，劉老師清晰的邏輯以及認真的態度使我們的論文更加嚴謹。能成為王老師和 劉老師的指導學生，並且在老師的指導之下完成我的碩士論文，對我來說是一種 驕傲和榮耀，在這裡我要非常感謝老師們為了我的論文所付出的時間以及心血。
同時要感謝林瑞青教授在口試上也給我許多寶貴的意見，讓我的論文更加縝密。
同樣身為老師的指導學生，佳軒、信蒼、芳如、亭均、珮璇、宜潔，在論文 的這一路上也給了我不少幫助，能和這些戰友們一起畢業是值得開心的。
父母親在我求學過程中給予我的關懷鼓勵是不可磨滅的，他們花了許多心血 使我在正確的軌道上自由發展，從來不逼迫我並且尊重我的決定，我對父母親的 愛意以及感恩之心是無法比擬的。同時慧怡在這段時間中給予我的支持是讓我不 斷向前的動力。
最後，要感謝台大會計系這五年來對於我的栽培，使我茁壯成長，我永遠以 身為台大會計的一份子感到光榮，希望未來台大會計系能以我為榮。
于智帆 謹誌於
台灣大學會計學研究所 2008/06
摘要 摘要 摘要 摘要
公司上市櫃前是否進行盈餘管理一直是會計研究的熱門議題，台灣的相關文 獻中有支持盈餘管理假說者，亦有支持無盈餘管理假說者。本研究之樣本包含西 元 1992 年至 2006 年在台灣證券交易所新上市之公司(499 家)以及在櫃臺買賣中 心新上櫃之公司(744 家)。本研究採用橫斷面 modified Jones model 估計裁量性流 動應計項目 (discretionary current accruals)，作為盈餘管理之代理變數。Ball and Shivakumar (2007) 提到公司 IPO 當年底之裁量性流動應計項目存在一些潛在的 問題，造成如果採用 IPO 當年底之裁量性流動應計項目去判斷公司是否進行盈餘 管理會產生偏差。本文除了檢視公司上市櫃當年底之裁量性流動應計項目外，更 深入檢視組成流動應計項目之變數個別變動。本研究認為公司上市櫃當年底之裁 量性流動應計項目乃取決於公司對於營運資本配置之決定，並認為以公司上市櫃 前兩年之裁量性流動應計項目作為公司上市櫃前是否進行盈餘管理的代理變數 更為合適。實證結果顯示公司上市櫃前並未進行盈餘管理，並且在上市櫃前一年 以及前二年比其他已經上市櫃公司更為條件保守。
關鍵字：盈餘管理、上市上櫃、裁量性流動應計項目、條件保守。
Abstract
Earnings management for newly listed firms
Name: Chih-Fan Yu June, 2008
Advisor: Taychang Wang, Ph.D.
Chiawen Liu, Ph.D.
Department of Accounting National Taiwan University
This study examines whether newly listed firms engage in earnings management before their listing. The sample includes 499 newly listed firms in the Taiwan Stock Exchange (TSE) market and 744 newly listed firms in the GreTai Securities (GTS) market between 1992 and 2006. This paper uses the cross-sectional modified Jones model to estimate discretionary current accruals as the proxy for earnings
management behavior. The study illustrates some potential biases related to the discretionary current accruals in the event year mentioned by Ball and Shivakumar (2007) and examines the fluctuations of individual working capital components. The discretionary current accruals in the event year are influenced by firms’ decision to deploy their working capital level, and this paper assumes the discretionary current accruals in the event year -1 and -2 are more suitable to test if newly listed firms manipulate their earnings. The empirical results are consistent with that newly listed firms do not engage in earnings management before their listing and even report more conditionally conservatively in event year -1 and -2.
Keywords: earnings management, IPO, newly listed, discretionary current accruals, conditional conservatism.
Content
Chapter 1. Introduction...1
1-1 Research Motivations and Purposes ...1
1-2 Research Contributions...3
1-3 Research Structure ...4
Chapter 2. Literature Review...7
2-1 Accruals Estimation Related Literatures ...7
2-2 Earnings Management around IPO process Literatures ...12
2-3 Earnings Management for Newly Listed Firms in Taiwan...16
Chapter 3. Research Methodology ...20
3-1 Hypothesis Development...20
3-2 Variables Measurement...25
3-3 Analysis Methodology ...27
3-4 Sample Selection and Data ...33
Chapter 4. Empirical Results and Analysis ...37
4-1 Pair-wise Correlations ...37
4-2 Cross-Sectional Modified Jones Model...38
4-3 Time-Series and Cross-sectional Characteristics of DCA ...44
4-4 Current Accruals Components for sample firms in year 0 ...49
4-5 Discretionary Current Accruals in the event year -1 and -2 ...57
4-6 Profitability index for newly listed firms around the event year ...59
4-7 Conditional Conservatism in event year -1 and -2 ...61
4-8 Out-of-sample test ...64
Chapter 5. Conclusions and Suggestions...67
5-1 Research Conclusions...67
5-2 Research Constraints ...70
5-3 Research Suggestions ...71
Figures
Figure 1.2: Research Flow Chart ...6
Figure 3.1: Listed Process Flow Chart...23
Figure 3.2: Time Line ...27
Figure 4.6: Profitability index trend for newly listed firms ...60
Tables
Table 3.1: Criteria for applicant firms to be listed in TSE and GTS markets ...24
Table 3.4.1: Sample selection ...34
Table 3.4.2: Sample Characteristics (Industry Distribution)...34
Table 3.4.3: Sample Characteristics (Time Distribution)...35
Table 3.4.4: Industry Adjustments ...36
Table 4.1: Pair-wise correlations...38
Table 4.2: Descriptive statistics of modified Jones Model estimations by industries..40
Table 4.3: Time-Series and Cross-sectional Characteristics of DCA ...46
Table 4.4: Current Accrual Components in the newly listed year ...52
Table 4.5: Discretionary Current Accruals in event year -1 and -2 for sample firms ..58
Table 4.6: Profitability index for newly listed firms around the event year ...60
Table 4.7: Conditional conservatism in event year -1 and -2...63
Table 4.8: Out-of-sample estimation biases in the event year ...66
Chapter 1. Introduction
1-1 Research Motivations and Purposes
A strong securities market is the showcase of a healthy national economy, and it provides firms the opportunities of direct financing. Private savings and potential capital can be channeled into the securities market to help the development of national economy and private sectors. There are two major stock markets in Taiwan, Taiwan Securities Exchange (TSE) market and GreTai Securities (GTS) market. A public issuing company applying for listing has to meet the requirements set by these two markets and then gets the final approval of the Securities and Futures Bureau.
Earnings management around large transactions and events is a popular topic in accounting literatures.1 This paper focuses on the earnings management at the process of going listed in the two major markets in Taiwan, due to the incentives and
opportunities for firms to manage earnings during this period.
Once firms decide to be listed in the securities market, they have to qualify the requirements (Table 3.1) set by the trading market and pass the strict examinations conducted by the official bureau. Moreover, firms also try every means to get higher IPO prices to expand the wealth of stockholders. These incentives and motivations may cause firms to manipulate their earnings in the listing process.
For firms already listed in the securities market, the investors can evaluate their business standing and forecast the trend of these firms more accurately through many public channels, like the audited financial statements, released operating performance reports, the characteristics of management, the consulting firms’ analysis reports, and even the media. However Rao (1993) reports that there is almost no news coverage about non-listed firms. The scarcity of information forces the investors to rely heavily on the prospectus, which may include the most recent three years’ financial statements.
Besides, firms can restate their financial statements in accordance with the generally
1 As in the literatures review chapter, Healy (1985), DeAngelo (1986), Jones (1991), Teoh et al.
(1998ab), Ball and Shivakumar (2007).
accepted accounting principles based on the Financial Accounting Standard NO.8 in Taiwan. All of these give managers the opportunities to manipulate earnings.
However, the newly listed firms face a higher reporting standard due to the market demand and regulatory requirements. The investors, lenders, and other users of financial statements demand higher reporting quality due to the information asymmetry between the firms and them. The process of going listed in the securities market also attracts the attention of the stakeholders and the public, independent auditors, boards, corporate lawyers, and the press. Listed firms also face greater regulatory requirements. Ball and Shivakumar (2007) show that the IPO firms report more conservatively instead of inflating earnings because of the demand for higher reporting quality.
Accruals are a popular proxy for earnings management (Healy [1985], DeAngelo [1986], Jones [1991], Dechow et al. [1995], Teoh et al. [1998b]). It plays an important role in these earnings management literatures. Accruals are supposed to reflect the firm’s underlying business standing more accurately because the cash-basis accounting numbers are influenced by the timing of cash receipts and payments.
However, the generally accepted accounting principles give managers the rooms to determine when to recognize revenues and expenses through accruals. It implicitly means the firms have the opportunities to manipulate their earnings by adjusting accruals. It is difficult for investors to distinguish the “real” accruals and “fake”
accruals. Teoh et al. (1998b) indicate that though discretionary long-term accruals also represent earnings management, managers have greater flexibility and control over current versus long-term accruals. And nondiscretionary portion of accruals are considered the responses to the firms’ business standings instead of proxies of earnings management. As a result, this paper uses the discretionary current accruals (DCA) as the main variable representing earnings management.
The main purpose of this study is to see whether newly listed firms manipulate their earnings before they are listed in the TSE and GTS markets. First, this paper uses the cross-sectional modified Jones model (Teoh et al. [1998b]) to estimate the
discretionary current accruals for sample firms in the event year-end. Then, this paper also re-examines the evidence found by using the first methodology and demonstrates
some potential problems related to it. Finally, this paper estimates the discretionary current accruals in event year -1 and -2 to examine whether firms manipulate their earnings before going listed in the two major stock markets in Taiwan. This paper assumes discretionary current accruals in event year -1 and -2 as the proxies of earnings management because those firms want to be listed in the two major stock markets should qualify the profitability requirement in most recent two fiscal years (Table 3.1). This study also tests the conditional conservatism of the newly listed firms in event year -1 and -2.
1-2 Research Contributions
This paper not only shows the fluctuations of discretionary current accruals in the event year for newly listed firms but examines the components of current accruals.
The difference between this study and other Taiwanese literatures is that it examines the fluctuations of individual working capital components in the event year and illustrates some potential problems related to it, such as the discretionary current accruals of firms in the “aggressive” group are too large to be reliable and may not be caused by earnings management.
The sample in this study includes newly listed firms in both TSE and GTS markets. The relevant literatures in Taiwan only examine the earnings management behavior for the TSE firms but no GTS firms.
From table 3.1, the newly listed firms have to qualify the profitability criteria that depend on the most recent two years’ accounting numbers. So this study uses the discretionary current accruals in the two years instead of the event year to examine the earnings management behavior for sample firms.
This paper also illustrates the problems related to the discretionary current accruals in the event year mentioned by Ball & Shivakumar (2007). The results suggest that the future researches in Taiwan should pay attention when using the event year-end discretionary current accruals to test the earnings management hypothesis around large transactions and events.
1-3 Research Structure
This study is organized into five chapters; the content of each chapter is described as follows:
Chapter 1: Introduction
This chapter is to illustrate the motivations, purposes, and contributions of this study and the research structure.
Chapter 2: Literatures Review
This chapter reviews the accruals estimation related literatures first. Then the second section reviews literatures about earnings management at IPO process. Finally, the chapter reviews the literatures about earnings
management of newly listed firms in Taiwan.
Chapter 3: Research Methodology
This chapter shows the development of hypothesis, measurement of variables, analysis methodology, and sample selection and data. The key variable in this study is discretionary current accruals (DCA). The sample includes newly listed firms in the Taiwan Stock Exchange (TSE) market and the GreTai Securities (GTS) market from 1992 to 2006.
Chapter 4: Empirical Results and Analysis
This chapter examines the empirical results and makes the interpretations.
Most importantly, it shows whether firms engage in earnings management before newly listed in the TSE and GTS markets.
Chapter 5: Conclusions and Suggestions The conclusions in this chapter are:
1. The discretionary current accruals are significantly positive in the event
year-end for the newly listed firms, but there are problems related to them and make them unreliable.
2. The discretionary current accruals in event year -1 and -2 for the newly listed firms and the conditional conservatism test suggest that the sample firms do not engage in earnings management and even report more conservatively in the two years before newly listed.
3. There may be potential biases in discretionary current accruals when using the cross-sectional modified Jones model to estimate them due to the out-of-sample estimation problem.
This chapter also makes some suggestions for further study.
The flow chart of this study is as follows:
Figure 1.2: Research Flow Chart Research Motivations
Develop Research Topics
Relevant Earnings Management Literatures Review
Understanding the TSE/GTS Market in Taiwan Relevant IPO
Literatures Review
Develop Hypothesis
Sample Selection and Data Gathering
Examine Discretionary Current Accruals around the Event Year
Out-of-sample Estimation Test
Empirical Results and Analysis
Conclusion and Suggestion Examine
Individual Working Capital Components Changes in Year 0
Conditional Conservatism Test
Chapter 2. Literature Review
This study mainly examines whether the newly listed firms engage in earnings management before their listing in Taiwan Stock Exchange market and GreTai Securities market. The discretionary current accruals is the main proxy for earnings management. To focus on this topic, this chapter reviews the literatures in the following three sections. First, this chapter organizes the famous literatures about accruals estimation. Second, this chapter discusses the literatures about earnings management at IPO. The literatures about earnings management for newly listed firms in Taiwan are in the last section.
2-1 Accruals Estimation Related Literatures
Accruals is the most popular proxy for earnings management because it reflects the overall impact of the accounting policies adopted by firms. How to estimate accruals and distinguish the discretionary portion from the total accruals are popular researches in accounting literatures. This section discusses some famous accruals estimation related literatures. This paper uses the change in sales to control the effect of firms’ business fluctuations (Jones [1991]) and subtracts the change in accounts receivable from the change in sales when calculating the nondiscretionary current accruals (Dechow et al. [1995]) because Dechow et al. (1995) show that the modified version of the Jones model has the better power to detect earnings management.
Healy (1985)
Healy examines the relation between managers’ managerial accounting decisions and earnings-based bonuses due to the incentives for managers to increase their compensation. This study is different from preceding papers because Healy not only examines the accruals which increase the earnings but the accruals which decrease the earnings. Healy separates its sample into three subsamples based on the existence of bonus plan upper bounds and lower bounds and compares the average accruals in each
subsample to observe if managers engage in earnings management.
Healy assumes managers are likely to adopt income-decreasing accruals when their performance is over the upper bounds of the bonus plan or under the lower bounds of the bonus plan in order to delay the earnings to the next period, and to adopt income-increasing accruals when their performance is in the middle of bounds to increase their bonus. The results in this study support its hypothesis that the accruals in company-years without upper and lower bounds of the bonus plan are significantly lower than those with upper and lower bounds. Healy considers that the accounting earnings are composed of cash flow from operations, discretionary accruals, and nondiscretionary accruals. Accruals are the differences between net income and operating cash flow.
t,
t
t DAC NDAC
TAC = + (1)
where:
TAC : Total accruals in year t, t
DAC : Discretionary accruals in year t, t
NDAC : Nondiscretionary accruals in year t. t
Healy also mentions that the discretionary accruals would be biased if we cannot distinguish these two portions of accruals accurately.
DeAngelo (1986)
DeAngelo investigates the accounting decisions made by firms during the management buyouts period. Due to the incentives for the firms to reduce the buyout compensation, the author hypothesizes that sample firms understate their earnings in periods before the management buyout, but the results are not consistent with the hypothesis. The author thinks the most plausible explanation is that, public
stockholders and their financial advisors carefully examine the financial statements of these firms for evidence of income-decreasing accounting.
In this study, DeAngelo (1986) revises the Healy (1985) model and uses the change in accruals to reduce the nondiscretionary accruals’ effect on earnings
manipulation test. The formula is:
).
( )
( 1 1
1 − −
− = − + −
− t t t t t
t TAC DAC DAC NDAC NDAC
TAC (2)
DeAngelo assumes the fluctuations in nondiscretionary accruals are random walk, so the expected value of the change in nondiscretionary accruals is zero. Under this assumption, the expected value of total accruals change represents the expected value of discretionary accruals change. So this paper uses the change in total accruals as a proxy for earnings management.
Jones (1991)
Jones uses empirical research to find out if firms try to decrease earnings by earnings manipulation during import relief investigation by the United States
International Trade Commission (ITC) in order to get benefit. Because ITC considers accounting numbers as the factors to decide which firm can get import protection, this provides an incentive for firms to manage their earnings. There are 25 companies in five different industries in the sample. The result of this study supports the hypothesis that managers make income-decreasing accruals during investigation, especially through the discretionary accruals.
Jones relaxes the assumption that nondiscretionary accruals are constant from period to period and develops the following model to estimate non-discretionary accruals:
, ) / ( ) / (
) / 1 (
/ it 1 i it 1 1i it it 1 2i it it 1 it
it A A REV A PPE A
TA − =α − +β ∆ − +β − +ε (3)
where:
TA = Total accruals in year t for firm i, it
REVit
∆ = Revenues in year t less revenues in year t-1 for firm i, PPE = Gross property, plant, and equipment in year t for firm i, it
−1
Ait = Total assets in year t-1 for firm i, εit = Error term in year t for firm i.
Jones assumes that nondiscretionary accruals of a firm would fluctuate from year to year because of the change in the economic circumstances and uses revenues to control the effect. Jones considers that the revenues can measure the firms’ operation conditions objectively. The reason the Gross PPE is included in this model instead of change in this account is that the total depreciation expense is included in the total accruals. The error term is the discretionary portion of the total accruals.
Friedlan (1994)
Friedlan assumes the IPO firms inflate their earnings in order to obtain the higher IPO prices and examines the accounting decisions made by issuers. The empirical results are consistent with the hypothesis that firms make income-increasing discretionary accruals before IPO.
Friedlan considers that the DeAngelo (1986) model is not suitable for the IPO firms because the IPO firms usually have high growth rates and the unusual growth affects the IPO firms’ operating performances, including accruals. Using the
DeAngelo model will contribute all the changes in total accruals to changes in discretionary accruals, but in fact, part of the changes should be contributed to the growth factor. The revised model in this study is:
− •
−
−
−
− = −
×
−
=
−
1 1 1
1
1
) (
t t t
t t
t t t
t t
t Sales
TAC Sales
TAC Sales
Sales Sales TAC
TAC TAC
TAC (4)
Friedlan revises the DeAngelo (1986) model and uses the sales growth rate to adjust the lagged total accruals, then standardizes the change in total accruals by this year’s sales.
Dechow, Sloan, and Sweeney (1995)
There are several popular models in earnings management literatures to estimate the discretionary and non-discretionary accruals. Dechow, Sloan, and Sweeney compare the specifications and power of test to evaluate these alternative models,
including the Healy Model, the DeAngelo Model, the Jones Model, and the Industry Model. They also develop a modified version of the Jones Model that the
nondiscretionary accruals are estimated as following:
), / ( ] / ) [(
) / 1
( −1 + 1 ∆ −∆ −1 + 2 −1
= i it i it it it i it it
it A REV REC A PPE A
NDA α β β (5)
where:
RECit
∆ = Net receivable in year t less net receivable in year t-1 for firm i.
The parameters used to calculate nondiscretionary accruals are still estimated from original Jones (1991) Model. The only difference between the Jones Model and the modified version is that when calculating nondiscretionary accruals, the modified Jones Model subtracts the change in net receivables from the change in revenues. This process implicitly assumes that all changes in credit sales are due to earnings
management. The reason is that it is easier to manipulate earnings through recognition of revenues on credit sales than on cash sales.
After a series of experiments, this study shows that all the models mentioned above are well specified for a random sample of event-years, but all lead to
mis-specified tests when firm-years having extreme financial performances. Besides, if variables used to detect earnings management are correlated with firm’s
performances, all the models considered are potentially mis-specified. So it is important to control these factors. Finally, the modified version of the Jones Model developed by Dechow, Sloan, and Sweeney shows the most power to detect earnings management.
Hribar and Collins (2002)
Estimating accruals is a very common procedure in accounting literatures. Due to the data availability problem of cash flow statements, many people use the successive balance sheets to estimate accruals. But this method is based on a presumption that the changes in working capital components are related to the accrual component of
revenues and expenses on the income statement. Once there are non-operating events, this presumption does not stand. The authors examine the accruals estimated both
from balance sheet changes and cash flow statements and demonstrate the errors caused by using balance sheets to estimate accruals.
The authors use three main non-operating events to examine the estimated accruals, which are mergers/acquisitions, divestitures, and foreign currency
translations. They divide their sample into four subsamples: firm-years with a merger or acquisition, firm-years with discontinued operations greater than $10,000,
firm-years with gain or loss on foreign currency translations greater than $10,000, and firm-years with none of the above events.
This paper shows that the accruals estimated from balance sheets in the “merger”
subsample are positively biased, and negatively biased in the “discontinued operations” subsample. So the authors suggest using the cash flow statements to estimate accruals, especially when there are non-operating events in the sample firm-years.
2-2 Earnings Management around IPO process Literatures
Literatures about earnings management around large transactions and events are countless. This section reviews some earnings management around IPO process literatures because the topic of this study is earnings management for newly listed firms in Taiwan. This study observes the significantly positive discretionary current accruals in the event year-end for newly listed firms as the evidence in Teoh et al.
(1998b) study. The difference between my study and Teoh et al. (1998b) is that they interpret these positive DCAs directly into earnings management for IPO firms. But this paper illustrates the potential biases related to the discretionary current accruals in the event year mentioned by Ball and Shivakumar (2007) and uses the DCAs in the event year -1 and -2 to examine the earnings management hypothesis instead of those in the event year.
Teoh, Welch, and Wong (1998b)
Based on Ritter (1991), “investors are periodically overoptimistic about the
earnings potential of young growth companies,” this study examines whether issuers of initial public offerings inflate their earnings by accruals in the IPO year and the subsequent stock returns. The authors assume that the IPO process is a good timing for issuers to manage their earnings due to the asymmetry information between investors and issuers. They also assume that the investors cannot identify which IPO firms manipulate earnings, so the high earnings on the financial statements included in the prospectus directly translate into a higher offering price. When these IPO firms start to trade on the stock market and are unable to maintain the earnings level, the investors begin to realize they were too optimistic about these companies and start to realize the real values of these firms. This would be reflected on the stock prices and caused the poor stock return performances thereafter.
The sample in this study includes 1,649 IPO firms in the U.S. between 1980 and 1992. The financial statement information is taken from the IPO year-end (year 0), so the numbers on the financial statements include both pre- and post-IPO periods.
Although the discretionary long-term accruals also represent earnings management, the authors emphasize the discretionary current accruals as the main variable because it is easier to control current accruals than long-term accruals. The nondiscretionary portions of total accruals reflect the change in business conditions of firms, so they are not considered proxies of earnings management. This paper uses the modified Jones Model to estimate the DCA at year 0 and divides the sample into four groups by DCA quartiles. Firms with highest DCA are included in the “aggressive” group and the group with lowest DCA is called “conservative”.
This study examines the relation between IPO firms’ earnings management and the long-term post-IPO stock underperformance. The empirical results show that the discretionary current accruals of IPO firms in year 0 are higher than non-issuers, and on average, firms classified in the most aggressive group have a 15% to 30% inferior performance than those classified in the most conservative group in the subsequent three years. In summary, the empirical results in the paper support the hypothesis that IPO firms inflate their earnings during the IPO process and the earnings management is related to the subsequent stock price performance.
Teoh, Wong, and Rao (1998c)
This paper examines mainly the issue-year earnings and the abnormal accruals in the IPO firms and the relation between the issue-year abnormal accruals and the subsequent stock returns.
The sample in this study consists of 1682 IPO firms going public between 1980 and 1990. IPO firms must meet the following criteria to be included: offer price > $1, gross proceeds > $1M, only common stock is offered, and the offering is handled by an investment banker. The methods used to estimate abnormal accruals in this paper include cross-sectional modified Jones (1991) model and Beneish (1994) M-score model. The operating performance is measured by three variables, return on sales of the IPO firms, industry-adjusted return on sales, and return on sales in relation to matched firms.
The empirical results reveal that the IPO firms report high earnings during the IPO process by reporting abnormal accruals; after the IPO, their earnings are significantly lower than non-issuing industry peers and matched non-issuers. Those IPO firms with the highest abnormal current accruals in the event year
underperformed the most in the following three years; but the expected current accruals, abnormal long-term accruals, and expected long-term accruals do not have the forecast power. Besides, the IPO firms are more likely than their peers to adopt accounting policies which could increase their earnings. Finally, the evidence in this paper is consistent with Teoh et al. (1998b) that the more abnormal accruals of IPO firms have, the worse their subsequent stock returns.
Ball and Shivakumar (2007)
Unlike popular literatures in the earnings management territory, the authors hypothesize the IPO firms report their financial statements more conservatively, because when one firm is going to initial public offering, it faces a higher demand for reporting quality from a broad range of stakeholders, like internal auditors,
independent auditors, boards, corporate lawyers, analysts, etc.
They also question the hypothesis and evidence of Teoh et al. (1998b) that firms inflate earnings during IPO year in order to get higher IPO prices. First, if IPO firms
inflate earnings by earnings management, they would attract the scrutiny from many market monitors, like auditors, analysts, as well as the regulatory, and might be detected. Second, poor reporting quality would cause the cost of capital to rise, which is not good for a growing firm. Third, the evidence from Teoh et al. (1998b) study is based on discretionary current accruals, which include the changes in working capital, estimated from modified Jones Model. The authors find that these accruals are
unreliable due to the following reasons:
The discretionary current accruals are too large to be reliable in Teoh et al.
(1998b) sample and would be detected by market monitors.
The accruals are estimated from balance sheet changes and are biased in the earnings inflation hypothesis.
Using accruals in year 0 is too late to influence the IPO price.
The DCA estimates are biased because of the high growth of these IPO firms and the IPO proceeds.
Some unusually high discretionary accruals are caused by the low value of deflator, pre-IPO total assets.
This study re-examines the Teoh et al. (1998b) sample of 1,649 U.S. IPO firms from 1980 to 1992, calculates current accruals both from balance sheet and cash flow statement, and uses either the Jones Model or the following piecewise linear Jones model adapted from Ball and Shivakumar (2005, 2006) to estimate normal current accruals:
,
4 *
3 2
1
0 it it it it it it
it Sales CFO DCFO DCFO CFO
CA =α +α ∆ +α +α +α +ν (6)
where:
CFO =Cash flow from operations, it
DCFO =Dummy indicator for negative cash flows that takes the value 1 if it
CFO <0 and 0 otherwise. it
The authors use the discretionary current accruals in year-1 instead of year 0 to run regressions and to do analysis. The empirical results of this paper are consistent with the higher reporting quality hypothesis. The authors also conclude that using the
traditional ways to estimate discretionary accruals around large transactions and events are unreliable.
2-3 Earnings Management for Newly Listed Firms in Taiwan
This section reviews the related literatures about earnings management for newly listed firms in Taiwan because the sample in this paper includes newly listed firms in TSE market and GTS market. The differences between this paper and the others below are as follows. This paper assumes the discretionary current accruals have the better power to test earnings management hypothesis because the managers have greater flexibility and control over current than long-term accruals (Teoh et al.
[1998b]). So this study uses the discretionary current accruals as the proxy for earnings management (Tai [1999]) instead of discretionary accruals (Jeng [1992], Su [1992], Lien [1993], Chen [1993], and Huang [1995]). This study finds the
significantly positive discretionary current accruals in the event year-end, consistent with Huang (1995) and Tai (1999), and further examines the individual working capital components changes. This study assumes the discretionary current accruals in the event year -1 and -2 can better test the earnings management hypothesis for newly listed firms because the potential biases with the discretionary current accruals in the event year (not mentioned by relevant literatures in Taiwan) and the criteria for newly listed firms to qualify (Table 3.1). The studies below only focus on the newly listed firms in the TSE market, but the sample in my study includes the newly listed firms both in the TSE market and GTS market. The conclusions in this paper are consistent with Huang (1995) that firms do not engage in earnings management before newly listed but not with Su (1992), Lien (1993), Chen (1993), and Tai (1999). Due to the preceding reasons why this paper is different from following studies, I believe the variables, measurement periods, and methodology this paper adopts provide more reliable evidence to test whether firms engage in earnings management before newly listed.
Jeng (1992)
The sample in Jeng (1992) study includes 60 newly listed firms between 1986 and 1990. This study examines whether newly listed firms manipulate their earnings by using accruals before their listing in order to raise the stock price. The authors compare the average three years accruals of sample firms before listing with the average three years accruals post listing to see if there is significant difference.
The empirical results show that the average three years’ accruals of sample firms before listing are significantly different from those post listing. However, from the perspective of each single sample firm, there are only 22 firms’ averages three years accruals before listing are larger than those post listing. So there is no concrete conclusion in this study.
Su (1992)
This paper examines whether newly listed firms increase their earnings
significantly before listing through discretionary accruals and which method the firms adopt to influent their accounting earnings. The sample in this study includes newly listed firms between 1985 and 1989. This paper uses the DeAngelo model to estimate the discretionary accruals and examines their fluctuations pre- and post-listing.
The results show that the sample firms’ accounting earnings have significant increases before their listing but the discretionary accruals have no significant fluctuations. Moreover, the author examines the fluctuations of the earnings components and finds that the non-operating revenues have significant increases.
Lien (1993)
This study examines whether newly listed firms manipulate their earnings before listing in order to raise the stock prices. The sample includes newly listed firms
between 1981 and 1990. The empirical results show that the newly listed firms tend to engage in earnings management through operating related accruals instead of changes in accounting method. The total accruals and operating related accruals fluctuate significantly in the period three years before listing and three years post listing.
However, the non-operating revenues and extraordinary items have no such
fluctuations.
Chen (1993)
This study mainly examines whether newly listed firms manipulate their earnings before listing through discretionary accruals and in which period, and the relation between auditors’ reputations and earnings management. The sample includes 70 newly listed firms between 1982 and 1991. The results show that the discretionary accruals of newly listed firms are significantly positive at the year before listing but there is no significant relation between auditors’ reputations and earnings
managements.
Huang (1995)
This study uses the discretionary accruals as a proxy to examine whether firms going listed in the Taiwan Stock Exchange (TSE) market engage in earnings
management around event years, and also to analyze the pre- and post-listing performances. Furthermore, this paper examines the relation between the
discretionary accruals and operating performance after listing, and the incentives for earnings management.
There are 135 newly listed firms (TSE) between 1985 and 1993 in the sample, and the author combines some similar industries into a new category, deletes the industries without enough observations. The final sample consists of six different industries. The discretionary accruals are estimated by using Jones Model and as a proxy of earnings management. Net income and operating cash flow are proxies of operating performance. The incentives for earnings management include firm age, listed period, and the quality of auditors and underwriters.
The empirical tests are performed by using univariate analysis, correlation analysis, and multivariate analysis. The results of empirical tests support the hypothesis that firms make income-increasing earnings management through
discretionary accruals in the newly listed year and the next year as well. Net income and cash flow increase before listing, but decline gradually after listing. The relation between the extent of earnings management before listing and operating performance
of post-listing is insignificantly negative. The three incentives for earnings
management are significantly associated with discretionary accruals in the first year after listing, but not in the event year.
Tai (1999)
This study examines whether newly listed firms engage in earnings management before listing and the subsequent stock returns. The sample includes 271 newly listed firms between 1982 and 1996. The proxies of earnings management include
discretionary current accruals, nondiscretionary current accruals, discretionary long-term accruals, and nondiscretionary long-term accruals. The analysis
methodology includes trend analysis, cumulative abnormal returns, Fama-French regression analysis, and Fama-MacBeth regression analysis. The empirical results show that the newly listed firms use discretionary current accruals to inflate their earnings at the listed year and the negative relation between the extent of earnings management and subsequent stock returns. Moreover, the discretionary current accruals is the better indicator to forecast the long-term stock returns than other three earnings management proxies.
Huang and Wu (2007)
This study links finance topics of initial public offerings and lockup period to examine the hypothesis that the timing of lockup expiration is crucial to the earnings management in the post-IPO period. The evidence shows a strong need of earnings management in the lockup period. Significantly positive discretionary accruals begin from the IPO quarter to the quarter right after expiration of first-stage lockup period.
Furthermore, the discretionary accruals in the end of second-stage lockup period are also significantly positive. The results indicate that the lockup period is crucial to the findings of significant earnings management in the IPO year and the following year.
This paper also examines five specific items of discretionary accruals. Among them, discretionary account receivables and discretionary inventories are most intensively used throughout IPO and both lockup periods.
Chapter 3. Research Methodology
3-1 Hypothesis Development
Firms can better reflect themselves by accrual-basis accounting, but the
accrual-basis accounting also gives managers the opportunities to manipulate earnings.
There are many relevant literatures about earnings management around large transactions and events (Healy [1985], DeAngelo [1986], Jones [1991], Teoh et al.
[1998b]).
The process to be listed in the TSE or GTS market gives managers both the incentives and opportunities to manage their earnings. Rao (1993) indicates that there is almost no news coverage about the IPO firms before their IPO year. This scarcity of information causes the serious information asymmetry between issuers and investors, forces the public to heavily rely on the prospectus. Consequently, the accounting numbers in the prospectus directly translate into the IPO price. Firms can boost their earnings through accruals to raise the IPO price, just like borrow earnings from future periods. Moreover, the investors are unable to understand the extent of earnings management. Besides, in order to fulfill the criteria (Table 3.1) to be listed in the TSE or GTS market, managers also have incentives to manage their earnings.
However, the financial statements included in the prospectus should be audited by auditors who may notice if the firms manipulate their earnings. But we all know that the auditor is responsible only for the compliance with general accepted accounting principles, and not for the most accurate representation of the firm’s condition. If firms manipulate their earnings but are still in accordance with GAAP, the auditor would still give the unqualified opinion reports.
In summary, due to the incentives and opportunities for firms to inflate earnings at the IPO year, Teoh et al. (1998b) examine this hypothesis and show that
discretionary current accruals of IPO firms in the IPO year are significant higher than non-issuers. This study uses the DCA as a proxy of earnings management to test if firms inflate their earnings through accruals at the event year.
Later, Ball and Shivakumar (2007) challenge the popular belief that firms inflate their earnings at IPO and question both the hypothesis and evidence in Teoh et al.
(1998b) study. Moreover, they give many reasons why the significant positive
discretionary current accruals at the IPO year are not reliable and show that IPO firms report more conservatively at IPO.
The IPO process attracts a broad range of stakeholders’ attention, such as analysts, underwriters, auditors, press, as well as enhanced regulatory scrutiny, all of them ask for higher reporting standards. And if the public believes that IPO firms may manipulate their earnings, there should be more serious monitors and detection risk for these firms. The inflation of earnings causes the subsequent deflation of earnings, and the poor reporting quality also raises the cost of capital. It is not good news for a growing firm needing external financing. Based on these reasons, Ball and
Shivakumar (2007) question the earnings inflation hypothesis assumed by Teoh et al.
(1998b).
Ball and Shivakumar (2007) also question the evidence in Teoh et al. (1998b) sample for the following reasons. The discretionary current accruals in Teoh et al.
(1998b) sample are too large to be credible, and some of them are even negative. The negative values are not in accordance with the hypothesis that firms inflate earnings to get higher IPO prices. Hribar and Collins (2002) show that if there are non-operating events in firm-years, the accruals estimated from balance sheet changes would be biased, and suggest using accruals directly from cash flow statements. Due to the database constraint (Chapter 3.2), this paper still estimates the discretionary current accruals from balance sheet changes.
Ball and Shivakumar (2007) further show the bias in fitting the accruals model to out-of-sample data. When using Jones model to estimate the parameters for non-IPO firms and put the parameters in the IPO firms to calculate their discretionary current accruals, there is an implicit hypothesis that nondiscretionary current accruals of the IPO and non-IPO firms are determined in the same way. But the extent of relation between accruals and changes in revenues depends on the firm’s stage in the life cycle.
Ball and Shivakumar (2007) assume that IPO firms are likely to have been
resource-constrained before the IPO, and then IPO proceeds relax such constraints,
making large increases in working capital, both unconditionally and conditionally on sales. This study examines this question by varying the parameters between newly listed firms and listed firms.
The accounting numbers in the IPO year-end (year 0) includes both pre- and post-IPO periods and are too late to influence the IPO prices. Further, once IPO firms get IPO proceeds, they are likely to change their working capital level and working capital components which are main factors to calculate accruals. Growth factor may cause positive accruals (income-increasing), no matter they are calculated from successive balance sheet changes or cash flow statements. However, growth may not affect the discretionary current accruals, because the Jones model uses change in sales to control it. Teoh et al. (1998b) use modified Jones model to estimate DCA, which is subtracting the changes in accounts receivable from changes in sales, this procedure implicitly assumes that all the credit sales are fraudulent. In summary, refer to Ball and Shivakumar (2007), there are many problems when using the event year-end (year 0) accounting numbers to estimate discretionary current accruals.
Finally, although the incentives and opportunities for newly listed firms to manipulate their earnings at IPO process seem reasonable, there are still many disadvantages for firms to manage their earnings. Newly listed firms are usually the hot news in Taiwan and certainly attract many stakeholders and the public’s attention, such as auditors, analysts, underwriters, and the press. If these firms engage in
earnings management, the chance to be caught is high due to the monitors of the regulatory bureau. There is also a risk of subsequent detection, and the litigation problem and the damage to their reputations would be severe. Furthermore, earnings management can only borrow earnings from later periods and the poor reporting quality could also increase the cost of capital, which is worrisome for newly listed firms that need external financing.
Both of the earnings management hypothesis and no earnings management hypothesis have its reasons and are supported by literatures. This study does not take side in the first, and adopts the methodology introduced in the chapter 3-3 to examine whether newly listed firms in the TSE and GTS markets engage in earnings
management.
Figure 3.1 shows the flow chart for applicant firms to be listed in the TSE market.
The flow chart is taken from the Taiwan Stock Exchange Corporation website.2 The unreported process for firms to be listed in the GTS market is similar.
Figure 3.1: Listed Process Flow Chart
This study also organizes the criteria for applicant firms to be listed in TSE and GTS markets in Table 3.1. It shows that the primary requirements for the applicant firms are duration of corporate existence, paid-in capital, profitability, and dispersion of shareholdings. The motivations of this study are derived from the profitability requirements that applicant firms have to achieve in the most recent two years (year -1 and -2).
2 http://www.tse.com.tw/
Applicant firms hand in applications
Audited by Taiwan Stock Exchange Corporation
Investigated by the TSE committee and board
Transfer to Taiwan Financial Supervisory Commission, Executive Yuan
Authorize the security underwriters to handle the IPO process
Turn to TSE to negotiate the list date
Formally newly listed in the TSE market
Table 3.1: Criteria for applicant firms to be listed in TSE and GTS markets
Requirements TSE market criteria3 GTS market criteria4
Duration of corporate existence
More than 3 years incorporated and registered under the Company Act
More than 2 years incorporated and registered under the Company Act
Capital stock NT$600 million (paid-in capital) NT$50 million (paid-in capital) Profitability (income
before tax of the share capital)
Does not have any accumulated deficit in the final accounting for the most recent fiscal year, and meet either of the following criteria:
1. Both of most recent 2 fiscal years: 6% or average 6% (most recent fiscal year larger than preceding fiscal year)
2. Both of most recent 5 fiscal years: 3%
Does not have any accumulated deficit in the final accounting for the most recent fiscal year, and meet the following criteria:
Both of most recent 2 fiscal years: 3% or average 3% (most recent fiscal year larger than preceding fiscal year)
Income before tax shall not be less than NT$4 million in the most recent fiscal year
Dispersion of shareholdings
1. The number of holders of registered shares shall be 1,000 or more
2. There are not less than 500 registered shareholders holding from 1,000 shares to 50,000 shares
3. The total number of shares held by such shareholders is 20% or more of the total issued shares, or at least 10 million shares
1. There are not less than 300 registered shareholders holding from 1,000 shares to 50,000 shares
2. The total number of shares held by such shareholders is 10% or more of the total issued shares or more than 5 million shares
Others Stocks shall have been traded on the emerging stock market for
six months or more
3 Data is from Taiwan Stock Exchange Corporation Rules Governing Review of Securities Listings.
4 Data is from GreTai Securities Market Rules Governing Review of Securities Traded on Over-the-Counter Markets.
3-2 Variables Measurement
Current Accruals (CA)
Although managers can manipulate earnings through current and long-term accruals, they have greater flexibility and control on the current portion. So this study focuses only on the current accruals. Based on the common definition of current accruals in the earnings management literatures (Jones [1995], Teoh et al. [1998b]), this study calculates the current accruals by using the following formula:
ies], ntLiabilit OtherCurre
TaxPayable ayable
[AccountsP -
ntAssets]
OtherCurre Inventory
ceivable AccountsRe
[ CA
+ +
∆
+ +
∆
= (7)
where:
CA : Current accruals calculated from balance sheet changes.
Discretionary and Nondiscretionary Current Accruals (DCA) (NDCA)
Accruals can be separated into two portions, discretionary and nondiscretionary.
Jones (1991) assumes that the nondiscretionary portion of accruals is caused by the changes of firms’ business conditions instead of manipulations, and uses change in sales to control the effects. This study uses the discretionary current accruals as a primary proxy of earnings management due to the greater flexibility and easier control on it. This paper uses the following modified version (Teoh et al. [1998b]) of the Jones model to estimate the nondiscretionary current accruals:
1 ,
1 1
1 0 1
it it
it it
it it
TA Sales TA
TA
CA α α +ε
∆
+
=
−
−
−
(8)
1 ,
1 1
1
0
∆ −∆
+
=
−
∧
−
∧
it it it
it
it TA
TR Sales
NDCA α TA α (9)
where:
CA : Current accruals in year t for firm i, it
−1
TAit : Total assets in year t-1 for firm i,
Salesit
∆ : Sales in year t less sales in year t-1 for firm i, TRit
∆ : Accounts receivable in year t less accounts receivable in year t-1 for firm i, εit : Residuals in year t for firm i.
Using the lagged total assets as a deflator is trying to decrease the problem of heteroskedasticity.
For each sample observation, this paper uses all the listed firms’ data with the same industry-year to run the regression, but drops the newly listed year observations, then put the parameters into the second formula to estimate the NDCA. Subtracting the change in accounts receivable from change in sales implicitly assumes that all the changes in credit sales are due to earnings management (Dechow et al. [1995]).
Finally, the discretionary current accruals in year t for firm i is the difference between CA/TAt-1 and NDCA:
.
1
it it
it
it NDCA
TA DCA = CA −
−
(10)
Net Income (NI) and Cash Flow from Operations (CFO)
Besides examining the discretionary current accruals around the newly listed period, this study also observes the earnings and cash flow from operations both pre- and post-listed years to see the changes of firms’ operating performances. These two accounting numbers are directly from financial statements and deflated by the previous year’s total assets. The industry-adjusted net income is obtained by subtracting the same industry-year median from the sample firms’ net income. The way to calculate the industry-adjusted cash flow from operations is the same. The formulas are:
1 ,
1 −
−
−
=
−
it it it
it
it TA
NI TA
adjustedNI NI
Industry (11)
− •
−
−
=
−
1
1 it
it it
it
it TA
CFO TA
O CFO adjustedCF
Industry (12)
Time Line for Earnings Management
This study mainly examines the discretionary current accruals around newly listed period and also observes the changes of earnings and operating cash flows, so the measurement time period are important. As shown in Figure 3.2, year 0 represents the first fiscal year-end of the newly listed firms while year -1 means the last fiscal year-end before going listed.
Figure 3.2: Time Line
3-3 Analysis Methodology
This study uses the modified version of Jones model to estimate the discretionary current accruals for sample firms around the newly listed years, and also calculates the industry adjusted net income and operating cash flow as two indicators for firms’
operating performance. This paper lists these three variables from two years before going listed (year -2) to subsequent four years (year 4) to examine the relation between discretionary current accruals and industry adjusted net income or operating cash flow. This study also calculates the p-value of Wilcoxon signed-rank test for these variables to test the significance of discretionary current accruals at the event year (year 0). The sample firms are separated into four groups based on the DCA
Newly listed year
Fiscal Year-end (Year 0)
Fiscal Year-end (Year -1) Fiscal
Year-end (Year -1) Fiscal
Year-end (Year -2)
Time
quartiles at year 0 to avoid the linear parameterization of regressions mentioned by Teoh et al. (1998b). Teoh et al. (1998b) interpret that the significantly positive DCA and accounting earnings at the event year-end are induced by earnings management.
But this paper casts doubt about their interpretations as following reasons.
First, the discretionary current accruals of sample firms in the “aggressive” group are too large to be reliable. It is not possible that firms inflate their account
receivables and inventories in such magnitude, which surely would be detected.
Second, the accounting numbers in the event year-end includes both pre- and post-listing period. That means any changes in working capital in the event year would be considered earnings management. The process of going listed in the stock market may cause the sample firms’ working capital levels to change because the proceeds from this process may relax the capital constraints of newly listed firms (Ball and Shivakumar 2007).
Third, Hribar and Collins (2002) show that the current accruals estimated from successive balance sheets would be biased if there are non-operating events, such as acquisition or divestiture. Hribar and Collins (2002) suggest that using cash flow statements to estimate current accruals is better. But due to the TEJ database constraint, the formulas used to calculate current accruals from balance sheets and cash flow statements are not the same. So, this paper is not going to test these
potential biases related to discretionary current accruals estimated from balance sheet changes.
This paper then conducts a detailed examination of the individual working capital components of the accruals in the event year and evaluates their changes and reasonableness.
Due to the potential problems related to the accounting numbers at the event year-end mentioned in previous paragraphs when it goes to the earnings management hypothesis. Hribar and Collins (2002) demonstrate that the last financial statements issued prior to the IPO (year -1) offer a more valid test of the earnings management and conservative reporting hypothesis. Table 3.1 shows that if firms want to be listed in the TSE or GTS markets, they have to qualify the profitability criteria in most recent two years (year -1 and -2). This study then estimates the discretionary current
accruals in event year -1 and -2 for sample firms. The discretionary current accruals are estimated by using the modified Jones model. This paper examines these
discretionary current accruals to see whether the newly listed firms engage in earnings management prior to their listing in the TSE and GTS markets.
Furthermore, this study also tests whether firms report conditionally
conservatively in their last two financial statements before going listed in the TSE and GTS market. Accounting conservatism is a popular topic in accounting literatures.
Basu (1997) defines conservatism as capturing accountants’ tendency to require a higher degree of verification for recognizing good news than bad news in financial statements. Under his interpretation of conservatism, earnings reflects bad news more quickly than good news. Accounting conservatism is divided into two general ways.
First, conservatism can be unconditional (or news independent), meaning that the accounting process determined at the inception of assets and liabilities yield expected unrecorded goodwill. Second, conservatism can be conditional (or news dependent), meaning that book values are written down under sufficiently adverse circumstances but not written up under favorable circumstances, with the latter being the
conservative behavior. Beaver and Ryan (2005) illustrate some examples for unconditional conservatism, such as immediate expensing of the costs of most
internally developed intangibles and historical cost accounting for positive net present value projects. Examples for conditional conservatism include lower of cost or market accounting for inventory and impairment accounting for long-lived tangible and intangible assets.
The role of accruals in Dechow et al. (1998) is to mitigate noise in operating cash flow. For example, purchasing inventory by cash would cause the negative operating cash flow but inventory would also rise based on the matching principle. The primary function of working capital accruals is thus to make the earnings less noisy than cash flow from operations. One implication is that the current accruals and cash flow from operations are negatively correlated.
Ball and Shivakumar (2005) provide a second role for accruals, timely
recognition of economic gains and losses, and hypothesize it is a source of positive but asymmetric correlation between accruals and cash flows. The positive correlation
