Earnings management prior seasoned equity offerings : pre- versus post- Canadian SOX

Abstract

Purpose: This study investigates the prevalence of accrual-based and real-based earnings management activities prior seasoned equity offerings (SEOs) for a sample of Canadian public firms between 1993 and 2008. This study also examines earnings management trends around reforms in the Canadian corporate governance regime brought by Canadian SOX (CSOX) Act. Design/methodology/approach: Both parametric (t-test) and non-parametric (Wilcoxon test) tests are used to examine the statistical significance of mean and median accrual and real-based manipulation in the year preceding the announcement of a SEO. Results are reported for the entire sample of Canadian SEOs as well as for pre- and post-CSOX periods. Findings: The results reveal evidence of accrual and real income-increasing manipulation in the year preceding SEO announcement dates. Furthermore, some evidence of a shift from accrualbased to real-based earnings manipulation is detected in the post-CSOX period indicating that new corporate governance mechanisms and codes put forth by CSOX Act may have contributed to enhancing the quality of financial reporting. Research limitations/Implications: This study provides evidence of income-increasing manipulation prior to SEOs that is constrained after the passage of CSOX Act. This change in earnings management trends might signal mitigation of the agency problem. However, this research faces some limitations. The main limitation is represented by the small number of observations in the final sample used for computing discretionary accruals metrics. This sample size reduction was also due to implementation of several criteria during sampling procedures. Practical implications: The findings of this study provide evidence for policy makers on the potency of their corporate governance legislation, CSOX. This is also of interest to equity investors whom might make more efficient decisions in their investments. Originality/value: This study provides the first analysis in Canada to test for accrual and realbased earnings management by SEO firms. Furthermore, this paper conducts the first examination of the role of CSOX in enhancing the quality of financial reporting, within the context of SEOs.