Impact of accrual and real-based earnings management on market liquidity and financial performance for UK SEOs

Abstract

Purpose: This study investigates the impact of earnings management on financial performance and the market liquidity for a sample of UK seasoned equity offerings (SEOs) between 2000 and 2020. This study also examines the occurrence of earnings management activities and their impact on market liquidity and financial performance around crucial events such as IFRS, the financial crisis, and Brexit. Design/methodology/approach: The sample consists of all UK SEOs, excluding financial industries, between the 1st of January 2000 and the 31st of December 2020. Univariate and multivariate analyses are conducted to examine the impact of earnings management on market liquidity and financial performance for UK SEOs. The study employs a cross-sectional version of the Jones model (Jones, 1991) adjusted by Kothari et al (2005) modifications to estimate discretionary accruals as a proxy for earnings management. To account for accrual-based earnings management activities, current accruals are used as a proxy. Also, total accruals are used as a robustness check. To detect real earnings management, three proxies measuring the abnormal levels of cash flow from operations, production costs, and discretionary expenditures will be used. Furthermore, an aggregate measure that combines the above three proxies is applied as a robustness check for real-based earnings management. Findings: The results reveal a significant positive impact of real-based earnings management on market liquidity. In addition, our findings show that both accrual and real-based earnings management have a significant positive impact on financial performance. As a further analysis, the outcomes show that both accrual and real-based earnings management have a significant positive effect on market liquidity in post-Brexit. On the other hand, real earnings management has a significant positive impact on earnings management in the post-IFRS period. Moreover, both accrual and real-based earnings management have a positive significant effect on financial performance during the financial crisis. Research limitations/implications: Few companies were dropped from the sample because of outliers, unavailable annual reports, and missing data for some variables. Practical implications: The findings highlight the positive effects of accrual-and real-based earnings management. Thus, it is of interest to the investors, analysts, and traders who might benefit from the valuable information in building their investment decisions. The study confirms that earnings management behavior changes around crucial events such as International Financial Reporting Standards, the Global Financial Crisis, and Brexit. The paper’s findings have significant implications for regulators and policymakers since firms may shift their earnings management strategies from accrual to real-based earnings management. Originality/value: This study provides the first analysis in the UK to test for accrual and realbased earnings management by SEO firms. Furthermore, this paper conducts the first examination using an aggregate measure to investigate the impact of real earnings management on market liquidity and financial performance. Also, it examines the role of IFRS in enhancing the quality of financial reporting within the context of UK SEOs. Moreover, this research contributes to the literature by investigating the behavior of both types of earnings management around crucial events such as the financial crisis and Brexit.