Closely Held Firms As Going Concerns

This current GAAP determination of a going concern is shortsighted for two important reasons. The most important deals with creditors and other stakeholders involved with the business. Do they enter into contracts with the business or with the individual owner/manager? Currently, they contract with both since, in reality, they make no determination whether a separate firm (entity) exists. The second deals with valuing a business. If the business is not really a separate going concern, it would typically be valued as the sum of its individual assets instead of the present value of its future cash flows. Many times when buying a business, the acquirer is really just buying the assets to start his own business. This is particularly true in most service businesses. The purpose of this paper is to advocate reintroducing a qualification to the going concern audit opinion when an entity separate from its owner/manager does not exist. Criteria for determination are also proposed. Arguably, this will make audited accounting statements more meaningful for closely-held firms. More important, this should produce information useful for potential creditors and outside owners. Traditionally, banks have extended loans to small, closely-held firms with only compiled statements; there was no need to provide audited statements. However, the process of lending is changing from a direct, face-to-face process between borrower and lender to an indirect one where credit scoring systems are used. Audited statements can provide better, higher quality information to lenders extending credit

Earnings Management, Stock Issues, and Shareholder Lawsuits

We study the relations among abnormal accounting accruals measures of earnings management, stock offers, post-offer stock returns, and related shareholder lawsuits. We find that accruals are abnormally high around stock offers, especially high for firms that are subsequently sued about their offers. These accruals tend to reverse after stock offers and are negatively related to post-offer stock returns. Reversals are more pronounced and stock returns are much lower for sued firms than for those that are not sued. In multivariate logistic regressions the incidence of lawsuits involving stock offers is significantly positively related to abnormal accruals around the offer and significantly negatively related to post-offer stock returns. Moreover, settlement amounts in the lawsuits are also significantly positively related to the abnormal accruals and significantly negatively related to post-offer stock returns. These results support the view that some firms opportunistically manipulate earnings upward before stock issues rendering themselves vulnerable to litigation

Earnings management: IPO valuation and subsequent performance

We examine the role of earnings management by firms prior to making initial public offerings (IPOs). Our results indicate that pre-IPO abnormal accruals are positively related to initial firm value. Entrepreneurs may seek to increase their offering proceeds, temporarily deceiving investors by opportunistically manipulating earnings through accruals management before going public. This would imply a negative relationship between abnormal accruals around the offer date and subsequent firm performance. Confirming earlier studies, we find that abnormal accruals during the offer year are significantly negatively related to subsequent firm stock returns. In addition, we find that abnormal accruals in the preceding year are also significantly negatively related to subsequent performance. Thus, it appears that aggressive pre-IPO earnings management both increases IPO proceeds and decreases subsequent returns to investors