Earnings Management, Stock Issues, and Shareholder Lawsuits

Abstract

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