Description
The purpose of this paper is to extend the literature on earnings management by
examining whether stock dividends provide management with an incentive to manipulate earnings.
Accounting Research Journal
Earnings management and the market performance of stock dividend issuing firms: NZ
evidence
Hardjo Koerniadi Alireza Tourani-Rad
Article information:
To cite this document:
Hardjo Koerniadi Alireza Tourani-Rad, (2008),"Earnings management and the market performance of stock
dividend issuing firms", Accounting Research J ournal, Vol. 21 Iss 1 pp. 4 - 15
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Marion R. Hutchinson, Majella Percy, Leyal Erkurtoglu, (2008),"An investigation of the association between
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J ournal, Vol. 21 Iss 3 pp. 239-262 http://dx.doi.org/10.1108/10309610810922495
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Earnings management and the
market performance of stock
dividend issuing ?rms
NZ evidence
Hardjo Koerniadi and Alireza Tourani-Rad
Faculty of Finance, School of Business, Auckland University of Technology,
Auckland, New Zealand
Abstract
Purpose – The purpose of this paper is to extend the literature on earnings management by
examining whether stock dividends provide management with an incentive to manipulate earnings.
Design/methodology/approach – This paper employs a re?ned accrual model that controls the
performance effects in estimating the part of accruals subject to managerial discretion.
Findings – Stock dividend issuing ?rms increase accruals substantially in the issue year followed by
poor earnings and stock price performance in the subsequent year. More importantly, discretionary
accruals of stock dividend issuing ?rms are negatively correlated with the declines in both future
earnings and abnormal stock returns.
Originality/value – This paper examines the hypothesis that stock dividend ?rms engage in
earnings management.
Keywords Earnings, Dividends, Stocks, Financial management, New Zealand
Paper type Research paper
1. Introduction
According to standard corporate ?nance textbooks, stock dividends have no effect on
shareholders’ wealth and are just a cosmetic accounting change, where the increase
in the common stock account attributed to stock dividend issues is offset by the decrease
in the retained earnings account[1]. Thus, assuming that the market is ef?cient, the stock
price of dividend issuing ?rms should adjust proportionally to the increase in the
outstanding shares. For example, a 2 for 1 stock dividend should reduce the share price
from$3 per share to $1 per share. Therefore, the total shareholders’ wealth is unaffected
by the stock dividend. In practice, however, ?rms do opt for stock dividends[2].
In this paper, we attempt to extend the literature on earnings management by
examining whether stock dividends provide management with an incentive to
manipulate earnings. Empirical evidence on earnings management around equity
issues has been substantially documented in the literature. For example, Teoh et al.
(1998a) ?nd that high accrual IPO ?rms have poor post-issue stock price performance.
Similar evidence is reported in the context of SEO. Teoh et al. (1998b) document that
DAs of SEO ?rms are negatively correlated with the ?rms’ poor long-run abnormal
returns. Using a different accrual model, Rangan (1998) ?nds that earnings
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
The authors thank the Editor, Professor Christine Ryan and the anonymous referees for their
helpful comments and suggestions. All remaining errors are the authors.
ARJ
21,1
4
Accounting Research Journal
Vol. 21 No. 1, 2008
pp. 4-15
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309610810891319
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management around SEO predicts the post-issue performance of both ?rms’ earnings
and abnormal stock returns. Louis (2004) ?nds strong evidence that ?rms issuing
equity to ?nance their mergers and acquisitions engage in upwardly earnings
management which explains the ?rms’ post-merger underperformance.
To date, to the best of authors’ knowledge, there has been no study examining the
hypothesis that stock dividend issuing ?rms engage in earnings management. Using a
re?ned accrual model, this study contributes to the literature by providing evidence of
earnings management associated with stock dividends.
We ?nd that, during the sample period, stock dividend issuing ?rms increase accruals
substantially in the issue year followed by poor earnings and stock price performances
in the post-issue year. Consistent with the earnings management hypothesis, we ?nd that
these poor earnings and stock price performances are negatively associated with DAs in
the issue year.
The remainder of the paper is structured as follows. In Section 2, we formulate the
hypotheses to be tested. Section 3 describes the research method and the sample selection
process. The results are reported in Section 4. We conclude the paper in Section 5.
2. Hypothesis development
The tax treatment to cash and stock dividend is the same in New Zealand, thanks to
the imputation tax system[3] implemented since 1988. Therefore, for tax purposes,
shareholders should be indifferent to these payout methods. Firms, however, may not
be indifferent to these options as they practically pay “nothing” to their shareholders if
they issue stock dividends. Shareholders may be aware of this situation and therefore,
the decision to pay stock dividends may not be a popular decision, unless investing
in the ?rm’s stocks is considered as a better choice than receiving cash dividends as the
latter option would incur transaction costs to reinvest the cash in the ?rms. This
situation might give an incentive for the ?rms’ managers to manage earnings in order
to temporarily in?uence the shareholders’ assessment of the ?rms’ stock price.
When managers of stock dividend issuing ?rms engage in earnings management,
they could arti?cially in?ate the accruals component of earnings in the event year by
“borrowing” earnings from the future year. Arti?cially increased accruals, however,
cannot continue for long and will eventually revert to their pre-managed level.
Therefore, the accruals of stock dividend issuing ?rms in the event year are predicted
to be higher than those of the pre-event year and should revert to their normal level in
the following year. Our ?rst hypothesis is:
H1. Stock dividend issuing ?rms report higher accruals in the event year than
those in the pre-event year.
Earnings management in the issue year causes future earnings to decrease because
some parts of accruals that belong to future earnings are shifted to current earnings.
Hence, if managers of stock dividend issuing ?rms manipulate earnings
opportunistically, the changes in future earnings are expected to be attributed to the
event year accruals. Therefore, our second hypothesis is:
H2. The changes in future earnings of stock dividend issuing ?rms are negatively
associated with accruals in the issue year.
Earnings
management
5
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Anderson et al. (2001) ?nd that the New Zealand stock market’s reaction to stock
dividend announcements in New Zealand is signi?cantly positive. However, prior
studies report that investors are not fully aware of managers’ opportunistic behaviour
on accruals (Bradshaw et al., 2001; Barth and Hutton, 2004). If investors fail to
recognize that earnings are managed upward, they will overprice the ?rms’ stock price.
When the effects of earnings management are reversed in the following year, the
market would react negatively to the unexpectedly lower future earnings. As a result,
the stock returns of stock dividend issuing ?rms are expected to be negatively
correlated with the accruals in the event year. Our third hypothesis is:
H3. The stock performance of stock dividend issuing ?rms is negatively
correlated with accruals in the issue year.
3. Methodology and data
3.1 Methodology
3.1.1 The accrual models. We measure total accruals as the difference between operating
earnings and operating cash ?ows. Computing accruals directly fromstatements of cash
?ows is a more precise measure of accruals and avoids measurement errors in
estimating accruals using the balance sheet approach (Austin and Bradbury, 1995;
Collins and Hribar, 2002). Operating earnings are de?ned as operating income after
depreciation but before interest expense, taxes and special items. All variables are
de?ated by total assets at the beginning of the period:
TA
it
¼ OE
it
2OC
it
ð1Þ
where, TA
it
, total accruals; OE
it
, operating earnings; OC
it
, operating cash ?ows.
To examine the hypothesis that managers opportunistically manage accruals, this
study employs the pooled cross sectional modi?ed Jones model to estimate the
discretionary part of accruals:
TA
it
¼ a
1
þa
2
ðDREV 2DRECÞ
it
þa
3
PPE
it
þf
it
ð2Þ
TA is the total accruals de?ned as the difference between operating earnings and cash
?ows from operations, DREV is the change in revenues, DREC is the change in account
receivables and PPE is property, plant and equipment. All variables are scaled by
lagged total assets. Nondiscretionary accruals (NDAs) are the ?tted values and DAs
are de?ned as the residuals of the model.
Although the modi?ed Jones model is not perfect in separating discretionary and
NDAs from total accruals, this model is widely used in the earnings management
literature and is the preferred alternative among the models available (Dechow et al.,
1995; Guay et al., 1996). The pooled cross sectional modi?ed Jones model is chosen
instead of the time series Jones model because the parameter estimates obtained from
the cross sectional version of the modi?ed Jones model are speci?ed better and do not
suffer from the survivorship bias as in the time series version (Subramanyam, 1996;
Bartov et al., 2000). In addition, few NZ ?rms have long historical data. Hence the
pooled cross sectional modi?ed Jones model generates a larger sample and increases
the power of the tests in this study.
The modi?ed Jones model, however, does not control for the performance effect on
accruals. Firms with high growth in performance are likely to report high accruals not
ARJ
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attributed to earnings management. Kothari et al. (2005) ?nd that the commonly used
DA models are too often biased toward rejecting the null hypothesis of no earnings
management. Kothari et al. (2005) suggest adjusting the performance effect on DA of
the sample ?rms by the control ?rms’ DA. The authors report that the
performance-matched DA model enhances the reliability of inferences from earnings
management research and is best applied to examine earnings management related to
corporate events such as stock offerings where control ?rms are not expected to report
the same degree of DAs. Therefore, in addition to the modi?ed Jones model, we also use
the performance-matched modi?ed Jones model. The performance-matched DA for the
sample ?rms is de?ned as the sample ?rm’s modi?ed Jones model DA in the event year
minus the matched ?rms’ modi?ed Jones model DA for the corresponding year.
3.1.2 Measurement of stock returns. One year ahead stock returns are computed as
the one year buy and hold returns measured using monthly returns from four months
after the end of the ?rms’ ?scal years[4]. To calculate the ?rms’ abnormal returns, we
construct ?ve equally weighted portfolios based on the market value of all ?rms[5] at
the beginning of the year and rebalanced every year. The buy and hold returns of these
portfolios are calculated within each quintile portfolio. Each sample ?rm is matched to
each portfolio according to its market value at the beginning of the year. The ?rm’s
abnormal return is de?ned as the difference between the stock return and the
size-matched portfolio return for the 12-month period:
AR
it
¼ R
it
2R
pt
ð3Þ
AR
it
is the size adjusted returns of ?rm i; R
it
is the raw return of the individual ?rm and
R
pt
is the size-matched portfolio return.
3.1.3 Measuring earnings management. To examine the hypothesis that the decline
in future earnings of stock dividend issuing ?rms is associated with earnings
management in the event year, this study employs a procedure similar to Rangan
(1998). First, changes in ?rms’ return on asset are regressed on DAs[6]:
DROA
itþ1
¼ a
0
þa
1
DA
it
þa
2
SGRO
it
þ V
itþ1
ð4Þ
DROA
itþ1
is the change in return on assets from year 0 to year 1, and DA
it
is ?rm i’s
DA in year 0. SGRO is the change in sales from year 21 to year 0. If managers borrow
future earnings to increase current earnings, DAs should explain the decline in future
earnings. Therefore, the coef?cient of DA
it
is expected to be negatively correlated with
the change in ROA
itþ1
.
Issuing ?rms may experience high sales growth and may need suf?cient funds to
invest in positive NPV projects. However, these projects may start generating revenues
from year 2 or 3 onwards. To avoid cash shortage, these ?rms may issue stock
dividends to provide returns to shareholders while saving cash. Rangan (1998) argues
that high sales growth would attract competition hence lower future pro?tability.
Thus, the change in earnings of issuing ?rms from year 0 to year 1 is expected to be
negatively correlated with the change in sales from year 21 to year 0. Accordingly, the
change in sales from year 21 to year 0, SGRO
it
, is added into the regression as an
additional variable for DROA
itþ1
.
Earnings management in the event year causes the shares of stock dividend issuing
?rms to be overpriced. When accruals reverse in the following year, the ?rms’ stock
price adjusts, respectively, to that lower than the expected future earnings. As a result,
Earnings
management
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the ?rms’ stock return is expected to be negatively correlated with the event year DAs.
Therefore, the following regression is estimated:
AR
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¼ a
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þa
1
NDA
it
þa
2
DA
it
þa
3
MV
it
þa
4
B=M
it
þ1
itþ1
ð5Þ
AR
itþ1
is computed as the stock’s buy and hold annual raw return minus the
size-matched buy and hold annual portfolio return. NDA
it
is nondiscretionary accruals
and DA
it
is discretionary accruals. The coef?cient of DA
it
is the coef?cient of interest in
this regression. However, NDA
it
is also included in the regression to evaluate the
relative information content for return between the two components of accruals.
Market value of ?rms’ equity, MV
it
, and book to market ratio, B/M
it
, are added as
control variables on the abnormal returns.
Bernard and Thomas (1990) argue that earnings follow a random walk with a drift.
Therefore, it is possible that instead of capturing the hypothesized earnings
management effect, DAs capture a post-earnings announcement drift effect.
To mitigate this problem, Rangan (1998) suggests using the following regression:
AR
itþ1
¼ g
0
þg
1
UE
itþ1
þg
2
DA
it
þg
3
MV
it
þg
4
B=M
it
þ1
itþ1
ð6Þ
where UE
itþ1
is the residuals from equation (4) and represents unexpected earnings for
year t þ 1[7]. DA
it
is information publicly available at the beginning of the abnormal
return calculation period. If the New Zealand market is ef?cient, the coef?cient of UE
should captures all the effect of the UE on stock returns, and the coef?cient of DA
should be zero. However, if investors are not aware of the earnings management in the
issue year, they overprice the issuing ?rms’ stock prices in the issue year. When the
post-issue year earnings are lower than expected, the errors are corrected accordingly.
Therefore, if issuing ?rms engage in earnings management, the coef?cient of DA will
be negatively correlated with the ?rm’s abnormal stock return.
3.2 Data
This study is conducted using non?nancial ?rms listed on the New Zealand Stock
Exchange from 1989 to 2003. The share price data, company reports and the
information on stock dividends are obtained from the Datastream database, the 2003
Datex company report ?les and the NZX Weekly Diary, respectively. Initially, a sample
of 64 ?rm year observations is obtained. Ten ?rm year observations are removed due
to lack of share price data, leaving with 29 stock dividend issuing ?rms with
54 ?rm-year observations during the sample period. In addition to the test sample, a
control sample is constructed by matching every ?rm in the sample with the closest
return on assets (ROA
it
) [8] of a cash dividend paying ?rm[9]. Return on assets is
measured as earnings before interest and taxes divided by lagged total assets (Bodie
et al., 2002).
4. Results
4.1 Earnings and stock performance of stock dividend issuing ?rms
Table I presents statistics of the characteristics of the test and the control ?rms from
year 21 to year þ1. Consistent with H1, the average accruals for stock dividend
issuing ?rms increase by 200 per cent[10] from 0.013 in the pre-issue year to 0.039 in
the issuing year. The mean (median) of NDAs, DAs and performance adjusted DAs in
the issue year are 0.027 (0.010), 0.012 (0.009) and 0.010 (0.016), respectively,
ARJ
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Table I.
Mean (median) values
of selected characteristics
for the test and the
control ?rms
Earnings
management
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(untabulated). The reversal effect of the increase in accruals in year 0 is re?ected in the
lower earnings in the post-issue year. One possible explanation for these results is that
because of the litigation risk associated with opportunistically increasing accruals,
these ?rms would try to postpone the full reversal effects of the accruals in year t þ 1.
In addition, earnings in the issue year are not statistically different from those of cash
dividend paying ?rms suggesting that the sample ?rms increase accruals so that their
reported earnings are comparable to those of control ?rms. On average, DA and
performance-matched DA drop in the year after the issue. This is consistent with
earnings management. The average (median) size adjusted abnormal return of the
stock dividend issuing ?rms is 22.68 per cent (26.94 per cent). Cash, however, drops
35 per cent from 0.148 in year 21 to 0.096 in the event year before slightly increasing to
0.100 in the following year. These ?ndings tend to be consistent with earnings
management.
In contrast, accruals of the control ?rms decrease by half, from 0.050 to 0.026, and
almost recover to the pre-event level in the post-issuing year. The average
buy-and-hold abnormal return is positive at 2.13 per cent. Cash?ows increase by
more than 20 per cent in the year when cash dividends are distributed and stay
relatively the same in the following year. These results indicate cash dividend paying
?rms do not engage in earnings management in New Zealand.
Table II reports results from regressing the change in return on assets on DAs and
the change in sales. Consistent with our second hypothesis, the coef?cient of DA
measured from the modi?ed Jones is statistically signi?cantly negative. A similar
result is obtained after controlling for the performance effect on accruals. The
coef?cient of DA from the performance matched modi?ed Jones models, although
smaller in magnitude, is also statistically negative. The negative coef?cient of DA
suggests that the decline of earnings in the following year (as reported in Table I) is
associated with the reversal effect of DAs in the event year.
Table III reports the results from regressing abnormal stock returns on the
discretionary and nondiscretionary components of accruals. When stock dividend
issuing ?rms deliberately manage earnings by increasing accruals in the issue year,
earnings in the post-issue year will decrease when accruals revert to their means.
If market participants are not aware of this earnings management but focus only on
reported earnings, the lower than expected earnings in the post-issue year will be
Modi?ed Jones model Performance matched model
Intercept 20.013 (21.09) 20.014 (21.12)
DA 20.253 (22.53)
*
20.201 (22.56)
*
SGRO 20.031 (20.92) 20.034 (21.01)
No. of obs. 54 54
Adj. R
2
(per cent) 8.75 8.97
Notes:
*
Signi?cant at 5 per cent. Changes in earnings are calculated as the change in return on assets
from year 0 to year 1. NDA (DA) is the ?tted (residual) value of the modi?ed Jones model. DA for the
performance matched model is de?ned as the sample ?rm’s DAs minus the control ?rm’s DAs. SGRO
is the change in sales from year 21 to year 0 scaled by total assets. Sample consists of 54 ?rm year
observations from 1989 to 2003. Two-tail t statistics are in parentheses
Table II.
Association between
earnings changes
and DAs
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re?ected on the ?rm stock price. The results reported in Table III show that
the coef?cients of NDA are negative but not statistically signi?cant which means that
the negative future ?rm abnormal returns are not attributed to the nondiscretionary
part of accruals.
The coef?cients of DA for both the modi?ed Jones and the performance matched
accrual models, however, are both signi?cantly negative. The negative coef?cients of
both measures of DAs suggest that DAs signi?cantly explain the decline in the future
abnormal stock returns. This result is consistent with our third hypothesis that
managers do use their discretion over accruals opportunistically to manipulate earnings
and ultimately the ?rm’s stock price in the issue year. The stock mispricing in the issue
year is corrected when the following period’s earnings are lower than anticipated due to
the reversal effects of this arti?cially high discretionary part of accruals.
Table IV reports the association between DAs and abnormal returns after
controlling for the unexpected component of earnings. As expected, the coef?cients of
UE, the unexpected component of earnings in year t þ 1, are signi?cantly and
positively related to abnormal returns. If the issuing ?rms do not engage in earnings
management, DAs should not be correlated with abnormal stock returns. The
abnormal stock return should be explained only by the unexpected component of
earnings in the year t þ 1. However, the results as reported in Table IV show that the
coef?cients of DAs in both accrual models, after controlling for the UE effect, are still
negative and statistically signi?cant. This evidence con?rms the previous results
reported earlier in Table III that earnings management in the issue year is correlated
with the poor abnormal stock returns[11].
4.2 Robustness test
The analyzes in this study use the size adjusted return as a measure of the abnormal
stock return to conserve sample size. As robustness check the market adjusted return
as a measure of abnormal stock return is used in this section and the analyzes on the
relation between stock abnormal returns and DAs of stock dividend issuing ?rms are
replicated.
Modi?ed Jones model Performance matched model
Intercept 0.127 (0.95) 0.149 (1.11)
NDA 21.471 (21.51) 21.821 (21.81)
*
DA 20.961 (21.92)
*
20.835 (22.12)
* *
MV 0.000 (20.13) 0.000 (20.53)
B/M 20.145 (21.07) 20.139 (21.06)
No. of obs. 54 54
Adj. R
2
(per cent) 2.30 3.80
Notes:
*
,
* *
Signi?cant at 10, 5 per cent, respectively. Abnormal return (AR) is the size-adjusted return
measured as the difference between the buy and hold stock return calculated from four months after
the end of the ?rm ?scal year minus the size-matched portfolio return. NDA (DA) is the ?tted (residual)
value of the modi?ed Jones model. DA for the performance matched model is de?ned as the sample
?rm’s DAs minus the control ?rm’s DAs. MV is market value of ?rms’ equity and B/M is book to
market ratio. Sample consists of 54 ?rm year observations from 1989 to 2003. Two-tail t statistics are
in parentheses
Table III.
DAs in the event year and
abnormal stock returns
Earnings
management
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Stock abnormal returns are calculated as the difference between stock returns and the
NZX index returns. Each ?rm’s stock returns are computed on monthly basis starting
from four months after its ?scal year end and cumulated for 12 months. Data on the
New Zealand market index, however, are available only from 1990 onwards reducing
the sample size to 49 events. Four events were excluded because they have cumulative
abnormal returns of more than 2100 per cent.
The results show that our earlier inferences remain unaltered. The mean (median) of
the sample’s abnormal return (untabulated) is 23.20 per cent (29.61 per cent). Panel A
of Table V shows that the coef?cients of DAs are still negatively and signi?cantly
(under the performance adjusted model) correlated with the ?rms’ abnormal returns.
The adjusted R
2
under the modi?ed Jones and the performance adjusted models
increases from 2.30 per cent and 3.80 per cent (in Table III) to 9.64 and 18.20 per cent,
respectively. Moreover, consistent with the previous results reported in Table IV, after
controlling for the drift effect on earnings, DAs signi?cantly explain the abnormal
stock returns (as reported in Panel B).
5. Conclusion
This study examines the earnings management hypothesis by the stock dividend
issuing ?rms during the period of 1989-2003 in New Zealand. Total accruals of the
issuing ?rms are found to increase substantially in the issue year before dropping to
the pre-issue level in the following year. Looking at the stock performance, the results
show that the stock prices of stock dividend issuing ?rms perform poorly subsequent
to the event. These ?ndings are in contrast with the pattern of accruals and the positive
stock price performance of similar ?rms paying cash dividends.
Consistent with the earnings management hypothesis, it is observed that DAs of
stock dividend issuing ?rms in New Zealand are negatively and signi?cantly
correlated with the declines in both ?rms’ future earnings and abnormal stock returns.
The negative association between DAs and the abnormal returns persists even
after controlling for the drift effect of earnings and the performance effect on DAs.
Modi?ed Jones model Performance matched model
Intercept 0.111 (1.04) 0.101 (0.96)
DA 20.968 (22.15)
* *
20.710 (22.07)
* *
UE 2.121 (3.59)
* * *
2.131 (3.58)
* * *
MV 0.000 (20.14) 0.000 (20.26)
B/M 20.181 (21.50) 20.165 (21.41)
No. of obs. 54 54
Adj. R
2
(per cent) 19.03 18.66
Notes:
*
,
* *
,
* * *
Signi?cant at 10, 5, 1 per cent respectively . Abnormal return (AR) is the size-adjusted
return measured as the difference between the buy and hold stock return calculated from four months
after the end of the ?rm ?scal year minus the size-matched portfolio return. NDA (DA) is the ?tted
(residual) value of the modi?ed Jones model. DA for the performance matched model is de?ned as the
sample ?rm’s DAs minus the control ?rm’s DAs. UE is the residuals from a regression of changes in
return on assets on the event year DAs. MV is market value of ?rms’ equity and B/M is book to market
ratio. Sample consists of 54 ?rm year observations from 1989 to 2003. Two-tail t statistics are in
parentheses
Table IV.
DAs in the event year and
abnormal returns after
controlling for the
unexpected component
of earnings
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These ?ndings complement the existing literature on earnings management around
stock issues.
Notes
1. See, for example, Brealey et al. (2000) and Ross et al. (2005).
2. Interestingly enough, the stock market reaction to the announcement of this corporate event
has generally been signi?cantly positive (see Lakonishok and Lev, 1987 for the US; Masse
et al., 1997 for Canada; Liljeblom, 1989 for Sweden; Anderson et al., 2001 for New Zealand).
The favourable short-term market reaction is justi?ed either as a positive signal regarding
future cash ?ows of ?rms or a change in their risk pro?le.
3. They both may or may not carry imputation tax credits.
4. By this time, ?rm ?nancial reports are expected to be publicly available (Alford et al., 1994;
Sloan, 1996).
5. The literature recommends sorting portfolios based on both market value and book to
market ratio. However, doing so would signi?cantly reduce the number of ?rms in each
portfolio. Besides, the literature on accruals reports a number of studies using size-adjusted
portfolio returns as a benchmark to measure ?rms’ abnormal returns (Sloan, 1996; Xie, 2001;
Bradshaw et al., 2001; Barth and Hutton, 2004).
6. In addition to SGRO, Rangan (1998) suggests including changes in capital expenditures as
an additional explanatory variable to control for the change in ROA. Missing observations
on this variable, however, would reduce the sample size to 29 observations. Therefore, we
decided to exclude this variable from the regression.
7. See Rangan (1998) for details.
Modi?ed Jones model Performance matched model
Panel A
Intercept 0.005 (0.03) 0.072 (0.48)
NDA 22.377 (21.87)
*
22.917 (22.39)
* *
DA 20.803 (21.38) 21.134 (22.51)
* *
MV 0.000 (0.24) 0.000 (20.29)
B/M 0.034 (0.21) 0.007 (0.05)
Adj. R
2
(per cent) 9.64 18.20
Panel B
Intercept 20.066 (20.54) 20.060 (20.50)
DA 21.059 (21.96)
*
20.943 (22.19)
* *
UE 2.253 (3.33)
* * *
2.086 (3.06)
* * *
MV 0.000 (0.39) 0.000 (0.12)
B/M 0.054 (0.38) 0.059 (0.44)
Adj. R
2
(per cent) 23.08 24.21
Notes:
*
,
* *
,
* * *
Signi?cant at 10, 5, 1 per cent respectively. Abnormal return (AR) is the market
adjusted return measured as the difference between the monthly stock return and the monthly NZX
All index return cumulated from four months after the end of the ?rm’s ?scal year for 12 months. NDA
(DA) is the ?tted (residual) value of the modi?ed Jones model. DA for the performance matched model
is de?ned as the sample ?rm’s DAs minus the control ?rm’s DAs. UE is the residuals from a regression
of changes in return on assets on the event year DAs. MV is market value of ?rms’ equity and B/M is
book to market ratio. Sample consists of 45 ?rm year observations from 1990 to 2003. Two-tail t
statistics are in parentheses
Table V.
DAs and abnormal stock
returns
Earnings
management
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8. The method of selecting control ?rms based on ROA in earnings management studies has
been widely employed in the literature (Barber and Lyon, 1996; Rangan, 1998; Teoh et al.,
1998a, b; Kothari et al., 2005).
9. On average, the incentive to manage earnings is not as strong as that of stock dividend
issuing ?rms. The pattern of accruals of cash dividend paying ?rms as reported in the result
section is consistent with this conjecture.
10. Signi?cant at the 5 per cent level based on a Wilcoxon test.
11. We ?nd similar results when NDA is included in the regression. The results are available
from the authors upon request.
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Corresponding author
Hardjo Koerniadi can be contacted at: [email protected]
Earnings
management
15
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doc_523569527.pdf
The purpose of this paper is to extend the literature on earnings management by
examining whether stock dividends provide management with an incentive to manipulate earnings.
Accounting Research Journal
Earnings management and the market performance of stock dividend issuing firms: NZ
evidence
Hardjo Koerniadi Alireza Tourani-Rad
Article information:
To cite this document:
Hardjo Koerniadi Alireza Tourani-Rad, (2008),"Earnings management and the market performance of stock
dividend issuing firms", Accounting Research J ournal, Vol. 21 Iss 1 pp. 4 - 15
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Marion R. Hutchinson, Majella Percy, Leyal Erkurtoglu, (2008),"An investigation of the association between
corporate governance, earnings management and the effect of governance reforms", Accounting Research
J ournal, Vol. 21 Iss 3 pp. 239-262 http://dx.doi.org/10.1108/10309610810922495
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Earnings management and the
market performance of stock
dividend issuing ?rms
NZ evidence
Hardjo Koerniadi and Alireza Tourani-Rad
Faculty of Finance, School of Business, Auckland University of Technology,
Auckland, New Zealand
Abstract
Purpose – The purpose of this paper is to extend the literature on earnings management by
examining whether stock dividends provide management with an incentive to manipulate earnings.
Design/methodology/approach – This paper employs a re?ned accrual model that controls the
performance effects in estimating the part of accruals subject to managerial discretion.
Findings – Stock dividend issuing ?rms increase accruals substantially in the issue year followed by
poor earnings and stock price performance in the subsequent year. More importantly, discretionary
accruals of stock dividend issuing ?rms are negatively correlated with the declines in both future
earnings and abnormal stock returns.
Originality/value – This paper examines the hypothesis that stock dividend ?rms engage in
earnings management.
Keywords Earnings, Dividends, Stocks, Financial management, New Zealand
Paper type Research paper
1. Introduction
According to standard corporate ?nance textbooks, stock dividends have no effect on
shareholders’ wealth and are just a cosmetic accounting change, where the increase
in the common stock account attributed to stock dividend issues is offset by the decrease
in the retained earnings account[1]. Thus, assuming that the market is ef?cient, the stock
price of dividend issuing ?rms should adjust proportionally to the increase in the
outstanding shares. For example, a 2 for 1 stock dividend should reduce the share price
from$3 per share to $1 per share. Therefore, the total shareholders’ wealth is unaffected
by the stock dividend. In practice, however, ?rms do opt for stock dividends[2].
In this paper, we attempt to extend the literature on earnings management by
examining whether stock dividends provide management with an incentive to
manipulate earnings. Empirical evidence on earnings management around equity
issues has been substantially documented in the literature. For example, Teoh et al.
(1998a) ?nd that high accrual IPO ?rms have poor post-issue stock price performance.
Similar evidence is reported in the context of SEO. Teoh et al. (1998b) document that
DAs of SEO ?rms are negatively correlated with the ?rms’ poor long-run abnormal
returns. Using a different accrual model, Rangan (1998) ?nds that earnings
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
The authors thank the Editor, Professor Christine Ryan and the anonymous referees for their
helpful comments and suggestions. All remaining errors are the authors.
ARJ
21,1
4
Accounting Research Journal
Vol. 21 No. 1, 2008
pp. 4-15
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309610810891319
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management around SEO predicts the post-issue performance of both ?rms’ earnings
and abnormal stock returns. Louis (2004) ?nds strong evidence that ?rms issuing
equity to ?nance their mergers and acquisitions engage in upwardly earnings
management which explains the ?rms’ post-merger underperformance.
To date, to the best of authors’ knowledge, there has been no study examining the
hypothesis that stock dividend issuing ?rms engage in earnings management. Using a
re?ned accrual model, this study contributes to the literature by providing evidence of
earnings management associated with stock dividends.
We ?nd that, during the sample period, stock dividend issuing ?rms increase accruals
substantially in the issue year followed by poor earnings and stock price performances
in the post-issue year. Consistent with the earnings management hypothesis, we ?nd that
these poor earnings and stock price performances are negatively associated with DAs in
the issue year.
The remainder of the paper is structured as follows. In Section 2, we formulate the
hypotheses to be tested. Section 3 describes the research method and the sample selection
process. The results are reported in Section 4. We conclude the paper in Section 5.
2. Hypothesis development
The tax treatment to cash and stock dividend is the same in New Zealand, thanks to
the imputation tax system[3] implemented since 1988. Therefore, for tax purposes,
shareholders should be indifferent to these payout methods. Firms, however, may not
be indifferent to these options as they practically pay “nothing” to their shareholders if
they issue stock dividends. Shareholders may be aware of this situation and therefore,
the decision to pay stock dividends may not be a popular decision, unless investing
in the ?rm’s stocks is considered as a better choice than receiving cash dividends as the
latter option would incur transaction costs to reinvest the cash in the ?rms. This
situation might give an incentive for the ?rms’ managers to manage earnings in order
to temporarily in?uence the shareholders’ assessment of the ?rms’ stock price.
When managers of stock dividend issuing ?rms engage in earnings management,
they could arti?cially in?ate the accruals component of earnings in the event year by
“borrowing” earnings from the future year. Arti?cially increased accruals, however,
cannot continue for long and will eventually revert to their pre-managed level.
Therefore, the accruals of stock dividend issuing ?rms in the event year are predicted
to be higher than those of the pre-event year and should revert to their normal level in
the following year. Our ?rst hypothesis is:
H1. Stock dividend issuing ?rms report higher accruals in the event year than
those in the pre-event year.
Earnings management in the issue year causes future earnings to decrease because
some parts of accruals that belong to future earnings are shifted to current earnings.
Hence, if managers of stock dividend issuing ?rms manipulate earnings
opportunistically, the changes in future earnings are expected to be attributed to the
event year accruals. Therefore, our second hypothesis is:
H2. The changes in future earnings of stock dividend issuing ?rms are negatively
associated with accruals in the issue year.
Earnings
management
5
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Anderson et al. (2001) ?nd that the New Zealand stock market’s reaction to stock
dividend announcements in New Zealand is signi?cantly positive. However, prior
studies report that investors are not fully aware of managers’ opportunistic behaviour
on accruals (Bradshaw et al., 2001; Barth and Hutton, 2004). If investors fail to
recognize that earnings are managed upward, they will overprice the ?rms’ stock price.
When the effects of earnings management are reversed in the following year, the
market would react negatively to the unexpectedly lower future earnings. As a result,
the stock returns of stock dividend issuing ?rms are expected to be negatively
correlated with the accruals in the event year. Our third hypothesis is:
H3. The stock performance of stock dividend issuing ?rms is negatively
correlated with accruals in the issue year.
3. Methodology and data
3.1 Methodology
3.1.1 The accrual models. We measure total accruals as the difference between operating
earnings and operating cash ?ows. Computing accruals directly fromstatements of cash
?ows is a more precise measure of accruals and avoids measurement errors in
estimating accruals using the balance sheet approach (Austin and Bradbury, 1995;
Collins and Hribar, 2002). Operating earnings are de?ned as operating income after
depreciation but before interest expense, taxes and special items. All variables are
de?ated by total assets at the beginning of the period:
TA
it
¼ OE
it
2OC
it
ð1Þ
where, TA
it
, total accruals; OE
it
, operating earnings; OC
it
, operating cash ?ows.
To examine the hypothesis that managers opportunistically manage accruals, this
study employs the pooled cross sectional modi?ed Jones model to estimate the
discretionary part of accruals:
TA
it
¼ a
1
þa
2
ðDREV 2DRECÞ
it
þa
3
PPE
it
þf
it
ð2Þ
TA is the total accruals de?ned as the difference between operating earnings and cash
?ows from operations, DREV is the change in revenues, DREC is the change in account
receivables and PPE is property, plant and equipment. All variables are scaled by
lagged total assets. Nondiscretionary accruals (NDAs) are the ?tted values and DAs
are de?ned as the residuals of the model.
Although the modi?ed Jones model is not perfect in separating discretionary and
NDAs from total accruals, this model is widely used in the earnings management
literature and is the preferred alternative among the models available (Dechow et al.,
1995; Guay et al., 1996). The pooled cross sectional modi?ed Jones model is chosen
instead of the time series Jones model because the parameter estimates obtained from
the cross sectional version of the modi?ed Jones model are speci?ed better and do not
suffer from the survivorship bias as in the time series version (Subramanyam, 1996;
Bartov et al., 2000). In addition, few NZ ?rms have long historical data. Hence the
pooled cross sectional modi?ed Jones model generates a larger sample and increases
the power of the tests in this study.
The modi?ed Jones model, however, does not control for the performance effect on
accruals. Firms with high growth in performance are likely to report high accruals not
ARJ
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attributed to earnings management. Kothari et al. (2005) ?nd that the commonly used
DA models are too often biased toward rejecting the null hypothesis of no earnings
management. Kothari et al. (2005) suggest adjusting the performance effect on DA of
the sample ?rms by the control ?rms’ DA. The authors report that the
performance-matched DA model enhances the reliability of inferences from earnings
management research and is best applied to examine earnings management related to
corporate events such as stock offerings where control ?rms are not expected to report
the same degree of DAs. Therefore, in addition to the modi?ed Jones model, we also use
the performance-matched modi?ed Jones model. The performance-matched DA for the
sample ?rms is de?ned as the sample ?rm’s modi?ed Jones model DA in the event year
minus the matched ?rms’ modi?ed Jones model DA for the corresponding year.
3.1.2 Measurement of stock returns. One year ahead stock returns are computed as
the one year buy and hold returns measured using monthly returns from four months
after the end of the ?rms’ ?scal years[4]. To calculate the ?rms’ abnormal returns, we
construct ?ve equally weighted portfolios based on the market value of all ?rms[5] at
the beginning of the year and rebalanced every year. The buy and hold returns of these
portfolios are calculated within each quintile portfolio. Each sample ?rm is matched to
each portfolio according to its market value at the beginning of the year. The ?rm’s
abnormal return is de?ned as the difference between the stock return and the
size-matched portfolio return for the 12-month period:
AR
it
¼ R
it
2R
pt
ð3Þ
AR
it
is the size adjusted returns of ?rm i; R
it
is the raw return of the individual ?rm and
R
pt
is the size-matched portfolio return.
3.1.3 Measuring earnings management. To examine the hypothesis that the decline
in future earnings of stock dividend issuing ?rms is associated with earnings
management in the event year, this study employs a procedure similar to Rangan
(1998). First, changes in ?rms’ return on asset are regressed on DAs[6]:
DROA
itþ1
¼ a
0
þa
1
DA
it
þa
2
SGRO
it
þ V
itþ1
ð4Þ
DROA
itþ1
is the change in return on assets from year 0 to year 1, and DA
it
is ?rm i’s
DA in year 0. SGRO is the change in sales from year 21 to year 0. If managers borrow
future earnings to increase current earnings, DAs should explain the decline in future
earnings. Therefore, the coef?cient of DA
it
is expected to be negatively correlated with
the change in ROA
itþ1
.
Issuing ?rms may experience high sales growth and may need suf?cient funds to
invest in positive NPV projects. However, these projects may start generating revenues
from year 2 or 3 onwards. To avoid cash shortage, these ?rms may issue stock
dividends to provide returns to shareholders while saving cash. Rangan (1998) argues
that high sales growth would attract competition hence lower future pro?tability.
Thus, the change in earnings of issuing ?rms from year 0 to year 1 is expected to be
negatively correlated with the change in sales from year 21 to year 0. Accordingly, the
change in sales from year 21 to year 0, SGRO
it
, is added into the regression as an
additional variable for DROA
itþ1
.
Earnings management in the event year causes the shares of stock dividend issuing
?rms to be overpriced. When accruals reverse in the following year, the ?rms’ stock
price adjusts, respectively, to that lower than the expected future earnings. As a result,
Earnings
management
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the ?rms’ stock return is expected to be negatively correlated with the event year DAs.
Therefore, the following regression is estimated:
AR
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¼ a
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þa
1
NDA
it
þa
2
DA
it
þa
3
MV
it
þa
4
B=M
it
þ1
itþ1
ð5Þ
AR
itþ1
is computed as the stock’s buy and hold annual raw return minus the
size-matched buy and hold annual portfolio return. NDA
it
is nondiscretionary accruals
and DA
it
is discretionary accruals. The coef?cient of DA
it
is the coef?cient of interest in
this regression. However, NDA
it
is also included in the regression to evaluate the
relative information content for return between the two components of accruals.
Market value of ?rms’ equity, MV
it
, and book to market ratio, B/M
it
, are added as
control variables on the abnormal returns.
Bernard and Thomas (1990) argue that earnings follow a random walk with a drift.
Therefore, it is possible that instead of capturing the hypothesized earnings
management effect, DAs capture a post-earnings announcement drift effect.
To mitigate this problem, Rangan (1998) suggests using the following regression:
AR
itþ1
¼ g
0
þg
1
UE
itþ1
þg
2
DA
it
þg
3
MV
it
þg
4
B=M
it
þ1
itþ1
ð6Þ
where UE
itþ1
is the residuals from equation (4) and represents unexpected earnings for
year t þ 1[7]. DA
it
is information publicly available at the beginning of the abnormal
return calculation period. If the New Zealand market is ef?cient, the coef?cient of UE
should captures all the effect of the UE on stock returns, and the coef?cient of DA
should be zero. However, if investors are not aware of the earnings management in the
issue year, they overprice the issuing ?rms’ stock prices in the issue year. When the
post-issue year earnings are lower than expected, the errors are corrected accordingly.
Therefore, if issuing ?rms engage in earnings management, the coef?cient of DA will
be negatively correlated with the ?rm’s abnormal stock return.
3.2 Data
This study is conducted using non?nancial ?rms listed on the New Zealand Stock
Exchange from 1989 to 2003. The share price data, company reports and the
information on stock dividends are obtained from the Datastream database, the 2003
Datex company report ?les and the NZX Weekly Diary, respectively. Initially, a sample
of 64 ?rm year observations is obtained. Ten ?rm year observations are removed due
to lack of share price data, leaving with 29 stock dividend issuing ?rms with
54 ?rm-year observations during the sample period. In addition to the test sample, a
control sample is constructed by matching every ?rm in the sample with the closest
return on assets (ROA
it
) [8] of a cash dividend paying ?rm[9]. Return on assets is
measured as earnings before interest and taxes divided by lagged total assets (Bodie
et al., 2002).
4. Results
4.1 Earnings and stock performance of stock dividend issuing ?rms
Table I presents statistics of the characteristics of the test and the control ?rms from
year 21 to year þ1. Consistent with H1, the average accruals for stock dividend
issuing ?rms increase by 200 per cent[10] from 0.013 in the pre-issue year to 0.039 in
the issuing year. The mean (median) of NDAs, DAs and performance adjusted DAs in
the issue year are 0.027 (0.010), 0.012 (0.009) and 0.010 (0.016), respectively,
ARJ
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3
Table I.
Mean (median) values
of selected characteristics
for the test and the
control ?rms
Earnings
management
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(untabulated). The reversal effect of the increase in accruals in year 0 is re?ected in the
lower earnings in the post-issue year. One possible explanation for these results is that
because of the litigation risk associated with opportunistically increasing accruals,
these ?rms would try to postpone the full reversal effects of the accruals in year t þ 1.
In addition, earnings in the issue year are not statistically different from those of cash
dividend paying ?rms suggesting that the sample ?rms increase accruals so that their
reported earnings are comparable to those of control ?rms. On average, DA and
performance-matched DA drop in the year after the issue. This is consistent with
earnings management. The average (median) size adjusted abnormal return of the
stock dividend issuing ?rms is 22.68 per cent (26.94 per cent). Cash, however, drops
35 per cent from 0.148 in year 21 to 0.096 in the event year before slightly increasing to
0.100 in the following year. These ?ndings tend to be consistent with earnings
management.
In contrast, accruals of the control ?rms decrease by half, from 0.050 to 0.026, and
almost recover to the pre-event level in the post-issuing year. The average
buy-and-hold abnormal return is positive at 2.13 per cent. Cash?ows increase by
more than 20 per cent in the year when cash dividends are distributed and stay
relatively the same in the following year. These results indicate cash dividend paying
?rms do not engage in earnings management in New Zealand.
Table II reports results from regressing the change in return on assets on DAs and
the change in sales. Consistent with our second hypothesis, the coef?cient of DA
measured from the modi?ed Jones is statistically signi?cantly negative. A similar
result is obtained after controlling for the performance effect on accruals. The
coef?cient of DA from the performance matched modi?ed Jones models, although
smaller in magnitude, is also statistically negative. The negative coef?cient of DA
suggests that the decline of earnings in the following year (as reported in Table I) is
associated with the reversal effect of DAs in the event year.
Table III reports the results from regressing abnormal stock returns on the
discretionary and nondiscretionary components of accruals. When stock dividend
issuing ?rms deliberately manage earnings by increasing accruals in the issue year,
earnings in the post-issue year will decrease when accruals revert to their means.
If market participants are not aware of this earnings management but focus only on
reported earnings, the lower than expected earnings in the post-issue year will be
Modi?ed Jones model Performance matched model
Intercept 20.013 (21.09) 20.014 (21.12)
DA 20.253 (22.53)
*
20.201 (22.56)
*
SGRO 20.031 (20.92) 20.034 (21.01)
No. of obs. 54 54
Adj. R
2
(per cent) 8.75 8.97
Notes:
*
Signi?cant at 5 per cent. Changes in earnings are calculated as the change in return on assets
from year 0 to year 1. NDA (DA) is the ?tted (residual) value of the modi?ed Jones model. DA for the
performance matched model is de?ned as the sample ?rm’s DAs minus the control ?rm’s DAs. SGRO
is the change in sales from year 21 to year 0 scaled by total assets. Sample consists of 54 ?rm year
observations from 1989 to 2003. Two-tail t statistics are in parentheses
Table II.
Association between
earnings changes
and DAs
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re?ected on the ?rm stock price. The results reported in Table III show that
the coef?cients of NDA are negative but not statistically signi?cant which means that
the negative future ?rm abnormal returns are not attributed to the nondiscretionary
part of accruals.
The coef?cients of DA for both the modi?ed Jones and the performance matched
accrual models, however, are both signi?cantly negative. The negative coef?cients of
both measures of DAs suggest that DAs signi?cantly explain the decline in the future
abnormal stock returns. This result is consistent with our third hypothesis that
managers do use their discretion over accruals opportunistically to manipulate earnings
and ultimately the ?rm’s stock price in the issue year. The stock mispricing in the issue
year is corrected when the following period’s earnings are lower than anticipated due to
the reversal effects of this arti?cially high discretionary part of accruals.
Table IV reports the association between DAs and abnormal returns after
controlling for the unexpected component of earnings. As expected, the coef?cients of
UE, the unexpected component of earnings in year t þ 1, are signi?cantly and
positively related to abnormal returns. If the issuing ?rms do not engage in earnings
management, DAs should not be correlated with abnormal stock returns. The
abnormal stock return should be explained only by the unexpected component of
earnings in the year t þ 1. However, the results as reported in Table IV show that the
coef?cients of DAs in both accrual models, after controlling for the UE effect, are still
negative and statistically signi?cant. This evidence con?rms the previous results
reported earlier in Table III that earnings management in the issue year is correlated
with the poor abnormal stock returns[11].
4.2 Robustness test
The analyzes in this study use the size adjusted return as a measure of the abnormal
stock return to conserve sample size. As robustness check the market adjusted return
as a measure of abnormal stock return is used in this section and the analyzes on the
relation between stock abnormal returns and DAs of stock dividend issuing ?rms are
replicated.
Modi?ed Jones model Performance matched model
Intercept 0.127 (0.95) 0.149 (1.11)
NDA 21.471 (21.51) 21.821 (21.81)
*
DA 20.961 (21.92)
*
20.835 (22.12)
* *
MV 0.000 (20.13) 0.000 (20.53)
B/M 20.145 (21.07) 20.139 (21.06)
No. of obs. 54 54
Adj. R
2
(per cent) 2.30 3.80
Notes:
*
,
* *
Signi?cant at 10, 5 per cent, respectively. Abnormal return (AR) is the size-adjusted return
measured as the difference between the buy and hold stock return calculated from four months after
the end of the ?rm ?scal year minus the size-matched portfolio return. NDA (DA) is the ?tted (residual)
value of the modi?ed Jones model. DA for the performance matched model is de?ned as the sample
?rm’s DAs minus the control ?rm’s DAs. MV is market value of ?rms’ equity and B/M is book to
market ratio. Sample consists of 54 ?rm year observations from 1989 to 2003. Two-tail t statistics are
in parentheses
Table III.
DAs in the event year and
abnormal stock returns
Earnings
management
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Stock abnormal returns are calculated as the difference between stock returns and the
NZX index returns. Each ?rm’s stock returns are computed on monthly basis starting
from four months after its ?scal year end and cumulated for 12 months. Data on the
New Zealand market index, however, are available only from 1990 onwards reducing
the sample size to 49 events. Four events were excluded because they have cumulative
abnormal returns of more than 2100 per cent.
The results show that our earlier inferences remain unaltered. The mean (median) of
the sample’s abnormal return (untabulated) is 23.20 per cent (29.61 per cent). Panel A
of Table V shows that the coef?cients of DAs are still negatively and signi?cantly
(under the performance adjusted model) correlated with the ?rms’ abnormal returns.
The adjusted R
2
under the modi?ed Jones and the performance adjusted models
increases from 2.30 per cent and 3.80 per cent (in Table III) to 9.64 and 18.20 per cent,
respectively. Moreover, consistent with the previous results reported in Table IV, after
controlling for the drift effect on earnings, DAs signi?cantly explain the abnormal
stock returns (as reported in Panel B).
5. Conclusion
This study examines the earnings management hypothesis by the stock dividend
issuing ?rms during the period of 1989-2003 in New Zealand. Total accruals of the
issuing ?rms are found to increase substantially in the issue year before dropping to
the pre-issue level in the following year. Looking at the stock performance, the results
show that the stock prices of stock dividend issuing ?rms perform poorly subsequent
to the event. These ?ndings are in contrast with the pattern of accruals and the positive
stock price performance of similar ?rms paying cash dividends.
Consistent with the earnings management hypothesis, it is observed that DAs of
stock dividend issuing ?rms in New Zealand are negatively and signi?cantly
correlated with the declines in both ?rms’ future earnings and abnormal stock returns.
The negative association between DAs and the abnormal returns persists even
after controlling for the drift effect of earnings and the performance effect on DAs.
Modi?ed Jones model Performance matched model
Intercept 0.111 (1.04) 0.101 (0.96)
DA 20.968 (22.15)
* *
20.710 (22.07)
* *
UE 2.121 (3.59)
* * *
2.131 (3.58)
* * *
MV 0.000 (20.14) 0.000 (20.26)
B/M 20.181 (21.50) 20.165 (21.41)
No. of obs. 54 54
Adj. R
2
(per cent) 19.03 18.66
Notes:
*
,
* *
,
* * *
Signi?cant at 10, 5, 1 per cent respectively . Abnormal return (AR) is the size-adjusted
return measured as the difference between the buy and hold stock return calculated from four months
after the end of the ?rm ?scal year minus the size-matched portfolio return. NDA (DA) is the ?tted
(residual) value of the modi?ed Jones model. DA for the performance matched model is de?ned as the
sample ?rm’s DAs minus the control ?rm’s DAs. UE is the residuals from a regression of changes in
return on assets on the event year DAs. MV is market value of ?rms’ equity and B/M is book to market
ratio. Sample consists of 54 ?rm year observations from 1989 to 2003. Two-tail t statistics are in
parentheses
Table IV.
DAs in the event year and
abnormal returns after
controlling for the
unexpected component
of earnings
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These ?ndings complement the existing literature on earnings management around
stock issues.
Notes
1. See, for example, Brealey et al. (2000) and Ross et al. (2005).
2. Interestingly enough, the stock market reaction to the announcement of this corporate event
has generally been signi?cantly positive (see Lakonishok and Lev, 1987 for the US; Masse
et al., 1997 for Canada; Liljeblom, 1989 for Sweden; Anderson et al., 2001 for New Zealand).
The favourable short-term market reaction is justi?ed either as a positive signal regarding
future cash ?ows of ?rms or a change in their risk pro?le.
3. They both may or may not carry imputation tax credits.
4. By this time, ?rm ?nancial reports are expected to be publicly available (Alford et al., 1994;
Sloan, 1996).
5. The literature recommends sorting portfolios based on both market value and book to
market ratio. However, doing so would signi?cantly reduce the number of ?rms in each
portfolio. Besides, the literature on accruals reports a number of studies using size-adjusted
portfolio returns as a benchmark to measure ?rms’ abnormal returns (Sloan, 1996; Xie, 2001;
Bradshaw et al., 2001; Barth and Hutton, 2004).
6. In addition to SGRO, Rangan (1998) suggests including changes in capital expenditures as
an additional explanatory variable to control for the change in ROA. Missing observations
on this variable, however, would reduce the sample size to 29 observations. Therefore, we
decided to exclude this variable from the regression.
7. See Rangan (1998) for details.
Modi?ed Jones model Performance matched model
Panel A
Intercept 0.005 (0.03) 0.072 (0.48)
NDA 22.377 (21.87)
*
22.917 (22.39)
* *
DA 20.803 (21.38) 21.134 (22.51)
* *
MV 0.000 (0.24) 0.000 (20.29)
B/M 0.034 (0.21) 0.007 (0.05)
Adj. R
2
(per cent) 9.64 18.20
Panel B
Intercept 20.066 (20.54) 20.060 (20.50)
DA 21.059 (21.96)
*
20.943 (22.19)
* *
UE 2.253 (3.33)
* * *
2.086 (3.06)
* * *
MV 0.000 (0.39) 0.000 (0.12)
B/M 0.054 (0.38) 0.059 (0.44)
Adj. R
2
(per cent) 23.08 24.21
Notes:
*
,
* *
,
* * *
Signi?cant at 10, 5, 1 per cent respectively. Abnormal return (AR) is the market
adjusted return measured as the difference between the monthly stock return and the monthly NZX
All index return cumulated from four months after the end of the ?rm’s ?scal year for 12 months. NDA
(DA) is the ?tted (residual) value of the modi?ed Jones model. DA for the performance matched model
is de?ned as the sample ?rm’s DAs minus the control ?rm’s DAs. UE is the residuals from a regression
of changes in return on assets on the event year DAs. MV is market value of ?rms’ equity and B/M is
book to market ratio. Sample consists of 45 ?rm year observations from 1990 to 2003. Two-tail t
statistics are in parentheses
Table V.
DAs and abnormal stock
returns
Earnings
management
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8. The method of selecting control ?rms based on ROA in earnings management studies has
been widely employed in the literature (Barber and Lyon, 1996; Rangan, 1998; Teoh et al.,
1998a, b; Kothari et al., 2005).
9. On average, the incentive to manage earnings is not as strong as that of stock dividend
issuing ?rms. The pattern of accruals of cash dividend paying ?rms as reported in the result
section is consistent with this conjecture.
10. Signi?cant at the 5 per cent level based on a Wilcoxon test.
11. We ?nd similar results when NDA is included in the regression. The results are available
from the authors upon request.
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Corresponding author
Hardjo Koerniadi can be contacted at: [email protected]
Earnings
management
15
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doc_523569527.pdf