Earnings Management and Long-Run Stock

November 10, 2022

Underperformance of Private Placements

Doping He, San Jose State University

David C. Yang, University of Hawaii at Manoa

Liming Guan, University of Hawaii at Manoa

ABSTRACT

The study investigates whether private placement issuers manipulate their earnings around

the time of issuance and the effect of earnings management on the long-run stock performance. We

find that managers of U.S. private placement issuers tend to engage in income-increasing earnings

management in the year prior to the issuance of private placements. We further speculate that

earnings management serves as a likely source of investor over-optimism at the time of private

placements. To support this speculation, we find evidence suggesting that the income-increasing

accounting accruals made at the time of private placements predict the post-issue long-term stock

underperformance. The study contributes to the large body of literature on earnings manipulation

around the time of securities issuance.

INTRODUCTION

This study seeks to accomplish two goals regarding the issuance of seasoned private

placements of common equity (hereafter, private placements): (1) to investigate managers’ earnings

manipulation behavior of U.S. issuers around the time of the issuance; (2) to examine whether such

earnings manipulation behavior helps explain the long-term post-issue stock underperformance.

Private placements, together with seasoned public offerings of common equity (SEO), are

two important vehicles by which public firms obtain equity financing. Contrary to seasoned public

offerings of common equity, which issue new equity to the general public, private placement issuers

sell new equity to a restricted number of investors. More than 30 percent of seasoned equity

financing from external investors in recent years has come from private placements (Federal Reserve

Bulletin, see Appendix A). While there is a sizeable body of literature on earnings management

around the time of seasoned public offerings and on the issuers’ post-issue stock underperformance,

research on these issues related to private placements is scarce.

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