Earnings management and the performance of seasoned private equity placements

Purpose - The purpose of this paper is to examine whether Japanese private placement issuers manipulate their earnings around the time of issuance and the relationship between earnings management and the post‐issue stock underperformance. Design/methodology/approach - Cross‐sectional modified Jones model is used to measure earnings management proxy – discretionary accruals. Control firms are developed to mitigate the impact of other factors on the measurement of earnings management. Different set of control firms is also developed to calculate abnormal stock returns. Findings - It is found that managers of Japanese private placement issuers tend to engage in income‐increasing earnings management around the time of the issuance. It is further speculated that earnings management serves as a likely source of investor overoptimism at the time of private placements. To support this speculation, evidence is found suggesting that the income‐increasing accounting accruals made at the time of private placements predict the post‐issue long‐term stock underperformance. Originality/value - The study contributes to the large body of literature on earnings manipulation around the time of securities issuance.