Earnings Accruals and Real Activities Management around Initial Public Offerings Peter Ising Earnings Accruals and Real Activities Management around Initial Public Offerings Evidence from Specifi c Industries Peter Ising Zurich, Switzerland Dissertation University of Zurich, 2013 ISBN 978-3-658-03793-2 ISBN 978-3-658-03794-9 (eBook) DOI 10.1007/978-3-658-03794-9 Th e Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografi e; detailed bibliographic data are available in the Internet at http://dnb.d-nb.de. Library of Congress Control Number: 2013950219 Springer Gabler © Springer Fachmedien Wiesbaden 2014 Th is work is subject to copyright. 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Springer DE is part of Springer Science+Business Media. www.springer-gabler.de To my family 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 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 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 ..................................................................................................................... 1 1.1 Motivation .................................................................................................................. 1 1.2 Objective..................................................................................................................... 4 2. Initial Public Offerings .................................................................................................... 5 2.1 Process of an IPO ........................................................................................................ 5 2.2 Motivations for Going Public ...................................................................................... 7 2.3 Industry Differences .................................................................................................... 9 3. Discretionary Reporting ................................................................................................ 11 3.1 Definition .................................................................................................................. 11 3.2 Earnings Accruals and Real Activities Management .................................................. 14 3.2.1 Earnings Accruals Management ..................................................................... 14 3.2.2 Real Activity Management............................................................................. 16 3.2.2.1 Overview ................................................................................................ 16 3.2.2.2 Sales ....................................................................................................... 17 3.2.2.3 CfO ......................................................................................................... 19 3.2.2.4 R&D ....................................................................................................... 19 3.2.2.5 SG&A ..................................................................................................... 20 3.2.2.6 Advertising ............................................................................................. 20 3.2.2.7 Discretionary Expenses ........................................................................... 21 3.2.2.8 Change in Inventory ................................................................................ 21 3.2.2.9 COGS ..................................................................................................... 22 3.2.2.10 Production .............................................................................................. 23 3.2.2.11 GAS ........................................................................................................ 23 3.3 IPO Specifics ............................................................................................................ 24 3.3.1 Agents and Motivation ................................................................................... 24 3.3.2 Discretionary Reporting ................................................................................. 26 3.3.2.1 Time ....................................................................................................... 26 3.3.2.2 Inflation vs. Deflation ............................................................................. 28 4. Literature Overview ...................................................................................................... 30 4.1 State of Research....................................................................................................... 30 4.2 Earnings Accruals Management ................................................................................ 31 XII Table of Contents 4.2.1 Teoh et al. (1998b) ......................................................................................... 31 4.2.2 Ball/Shivakumar (2008) ................................................................................. 32 4.3 Real Activities Management ..................................................................................... 32 4.3.1 Roychowdhury (2006) ................................................................................... 32 4.3.2 Gunny (2010) ................................................................................................ 34 4.4 Multi-Dimensional Approaches ................................................................................. 34 4.4.1 Cohen/Zarowin (2010) ................................................................................... 34 4.4.2 Fedyk et al. (2012) ......................................................................................... 35 5. Hypotheses and Models ................................................................................................. 37 5.1 Hypotheses Development .......................................................................................... 37 5.1.1 Research Aspects ........................................................................................... 37 5.1.2 Hypotheses for Periods around IPO ............................................................... 38 5.1.2.1 Distinction between Years....................................................................... 38 5.1.2.2 Specifics of Sales and CfO ...................................................................... 42 5.1.2.2.1 Hypothesis Sales 2.............................................................................. 42 5.1.2.2.2 Hypothesis Cash Flow 2 ..................................................................... 43 5.1.3 Hypotheses for Specific Industries ................................................................. 44 5.1.3.1 High-Growth vs. Well-Established Industries .......................................... 44 5.1.3.2 Profitable vs. Unprofitable Industries ...................................................... 48 5.2 Econometric Models ................................................................................................. 51 5.2.1 General .......................................................................................................... 51 5.2.2 Accruals and Real Activity Models ................................................................ 53 5.2.2.1 Earnings Accruals Models....................................................................... 53 5.2.2.2 Sales Models ........................................................................................... 54 5.2.2.3 Specific Real Activity Models ................................................................. 56 5.2.3 Research Design ............................................................................................ 60 6. Empirical Study ............................................................................................................. 64 6.1 Sample and Data ....................................................................................................... 64 6.2 Descriptive Statistics ................................................................................................. 66 6.3 Empirical Results ...................................................................................................... 82 6.3.1 Results for Periods around IPO ...................................................................... 82 6.3.1.1 Hypothesis Earnings Accruals 1 .............................................................. 82 6.3.1.1.1 Biotech ............................................................................................... 82 6.3.1.1.2 Internet ............................................................................................... 85 6.3.1.1.3 Technology ........................................................................................ 85 6.3.1.1.4 Construction ....................................................................................... 86 6.3.1.1.5 Wholesale........................................................................................... 86 6.3.1.2 Hypotheses Sales 1 and 2 ........................................................................ 87 6.3.1.2.1 Biotech ............................................................................................... 87 Table of Contents XIII 6.3.1.2.2 Internet ............................................................................................... 92 6.3.1.2.3 Technology ........................................................................................ 94 6.3.1.2.4 Construction ....................................................................................... 95 6.3.1.2.5 Wholesale........................................................................................... 96 6.3.1.2.6 Hypothesis Sales 2.............................................................................. 97 6.3.1.3 Hypotheses CfO 1 and 2 ......................................................................... 97 6.3.1.3.1 Biotech ............................................................................................... 97 6.3.1.3.2 Internet ............................................................................................... 99 6.3.1.3.3 Technology ...................................................................................... 101 6.3.1.3.4 Construction ..................................................................................... 102 6.3.1.3.5 Wholesale......................................................................................... 102 6.3.1.3.6 Hypothesis CfO 2 ............................................................................. 103 6.3.1.4 Hypothesis R&D 1 ................................................................................ 104 6.3.1.4.1 Biotech ............................................................................................. 104 6.3.1.4.2 Internet ............................................................................................. 107 6.3.1.4.3 Technology ...................................................................................... 108 6.3.1.4.4 Construction ..................................................................................... 109 6.3.1.4.5 Wholesale......................................................................................... 109 6.3.1.5 Hypothesis SG&A 1 ............................................................................. 110 6.3.1.5.1 Biotech ............................................................................................. 110 6.3.1.5.2 Internet ............................................................................................. 111 6.3.1.5.3 Technology ...................................................................................... 113 6.3.1.5.4 Construction ..................................................................................... 114 6.3.1.5.5 Wholesale......................................................................................... 115 6.3.1.6 Hypothesis Advertising 1 ...................................................................... 115 6.3.1.6.1 Biotech ............................................................................................. 115 6.3.1.6.2 Internet ............................................................................................. 116 6.3.1.6.3 Technology ...................................................................................... 118 6.3.1.6.4 Construction ..................................................................................... 118 6.3.1.6.5 Wholesale......................................................................................... 118 6.3.1.7 Hypothesis Discretionary Expenses 1 .................................................... 119 6.3.1.7.1 Biotech ............................................................................................. 119 6.3.1.7.2 Internet ............................................................................................. 122 6.3.1.7.3 Technology ...................................................................................... 122 6.3.1.7.4 Construction ..................................................................................... 123 6.3.1.7.5 Wholesale......................................................................................... 124 6.3.1.8 Hypothesis Change in Inventory 1......................................................... 124 6.3.1.8.1 Biotech ............................................................................................. 124 6.3.1.8.2 Internet ............................................................................................. 127
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