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Earnings management by firms announcing earnings after SEC filing.

Article Excerpt
Abstract

This study examines motivation and stock market reactions of firms announcing earnings in the Wall Street Journal (WSJ) after filing with the Security Exchange Commission (SEC). Most firms announce earnings in the WSJ before SEC filing. Firms that reverse this sequence are voluntarily delaying public earnings announcements. The authors find that these firms are not only poor financial performers but also engage in earnings managements. They are delaying their WSJ announcements to postpone announcing bad news. The authors find significant stock price reactions to both the SEC filing and the WSJ announcement. The price reaction to earnings is incomplete at the SEC filings. The market continues reacting to firms' subsequent WSJ announcements as if the SEC filing fails to communicate earnings information to some investors. (JEL G10)

Introduction

This study examines motivations and stock market reactions to firms announcing earnings in the Wall Street Journal (WSJ) after formal filing with the Security Exchange Commission (SEC). Given that most firms announce earnings in the WSJ before the SEC filing, the firms that reverse this sequence are special cases where public earnings announcements are voluntarily delayed. These firms have a lower return on assets and a higher leverage ratio than otherwise comparable firms. They experience disappointing quarterly earnings and operating cash flows. These findings are consistent with the notion that firms delay announcing earnings to postpone announcing bad news (for example, Bowen et al. [1992]; Patell and Wolfson [1982]; Trueman [1990]). Moreover, these firms engage in earnings management by booking significant, income-increasing accruals. This suggests that the probability of earnings management is high where public earnings announcement are voluntarily delayed. There are stock market reactions at both the S EC filing and the WSJ announcement dates. This evidence suggests that the initial market reaction to earnings at the firms' SEC filing is incomplete. The stock market continues reacting to earnings news in the firms' subsequent WSJ earnings announcements. The market fails to recognize voluntarily delaying public earnings announcement as a signal for bad news and adjust stock price accordingly.

Previous studies on earnings announcement timing focus on stock market reaction to firms whose earnings announcements are delayed (for example, Chambers and Penman [1984]; Kross and Schroeder [1984]). They compare firms' current earnings announcement date to an expected date based on the prior quarters. A firm is classified as a delayed firm if its current earnings announcement is later than the expected date. This study, on the other hand, identifies delayed firms by comparing the dates of firms' WSJ announcement to their SEC filing. A firm is classified as a delayed firm only if its WSJ announcement is subsequent to its SEC filing. These firms are voluntarily delaying their public announcement although the earnings information is clearly available to the managers before the WSJ announcement. The authors consider this sample as a unique subset of those used by prior studies. Prior studies included earnings announcement delay due to both voluntary and involuntarily reasons. For instance, a prior study will cl assify a firm as a delayed firm when earnings information is not available to the managers at an expected announcement date, a case of involuntary delay. Here the focus is on cases where the delay is voluntary. This is necessary to address the research questions, namely, what motivates managers to delay public release of earnings information, whether managers engage in earnings management, and how the stock market reacts to the delay.

To address these research issues, inter-firm tests were conducted to compare voluntarily delayed firms to firms that followed the normal reporting sequence with a WSJ announcement before the SEC filing. The intra-firm tests compare the quarters when firms voluntarily delay their earnings announcement to the quarters when firms follow the normal reporting sequence. These inter or intra-firm tests are conducted on a variety of financial and performance measures.

The levels of accounting accruals were examined and inter or intrar-firm difference tests for signs of earning management were conducted. Prior research shows that total accruals include discretional and non-discretional components, and the later are related to changes in activity levels and scale of fixed assets and thus not subject to management discretion (for example, Jones [1991]; Cahan [1992]; Hall and Stammerjohan [1997]). The same model is used as in prior research to estimate the discretional component of accruals that are subject to management discretion through choices of accounting estimates and methods. Results show that firms book significantly larger income-increasing discretional accruals when the firm voluntarily delays public earnings announcement. In contrast, firms that follow the normal reporting sequence have slightly income-decreasing, although not significant, discretional accruals. This is viewed as evidence suggesting earnings management by firms voluntarily delaying their WSJ announ cements.

Abnormal returns are computed around the SEC filing and the WSJ announcement dates for the sample firms to examine how the stock market reacts...

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