Earnings Management and Expected Dividend Increases Around Seasoned Share Issues: Evidence from Finland

Earnings Management and Expected Dividend Increases Around Seasoned Share Issues: Evidence from Finland

JUHA KINNUNEN Helsinki School of Economics - Department of Accounting and Finance MATTI KELOHARJU Helsinki School of Economics EERO KASANEN Helsinki School of Economics JYRKI NISKANEN University of Tampere

Abstract:

This paper suggests that firms use their opportunities for earnings management to inform the capital market of the quality of their equity issues. We argue that firms issuing new shares with higher discounts, and hence with larger expected dividend increases, are likely to report larger earnings in excess of the benchmark defined by current dividends than firms issuing shares at lower discounts or not issuing shares at all. These excess earnings are useful to the issuing firms because they reinforce the buffer of retained earnings, thereby strengthening the good news of the expected dividend increase implied by the issue announcement. Our empirical results are consistent with this argument. The findings indicate (1) that by the year of a share issue, (cumulative abnormal) excess earnings are significantly larger in issuing than in non-issuing firms; (2) that there is a significant positive correlation between the abnormal excess earnings and the expected dividend increase of the issue announcement; and (3) that the (market-adjusted) stock return around the issue announcement has a significant positive correlation with the abnormal excess earnings and with the expected dividend increase, while there is also a significant interactive effect such that excess earnings corroborate the information conveyed by the expected dividend increase.

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