Earnings Management : A Study of Equity Rights Issues in India

Earnings management occurs when managers use judgment in financial reporting and in structural transactions to alter financial reports either to mislead some stakeholders about the underlying performance of the company, or to influence contractual outcomes that depend on reported financial performance. Many research studies have been conducted to investigate the earnings management in developed economies. Due to the regulated operating environment in India until 1992, earnings management was not a fertile topic for research. But, post-1992, companies are given freedom to price their capital issues. This freedom motivates the issuers to manage their earnings prior to capital issues. The objective of the study is to investigate if firms in India manage earnings prior to their launching of equity rights issues. The study uses Discretionary Current Accruals (DCAs) to measure the extent of earnings management. Modified Jones Model is used to estimate the adjusted DCAs during the three years prior to the rights issue (pre-issue period) and three years after the rights issue (post-issue period). The DCAs of rights issuing firms are adjusted for DCAs of control sample (non-rights issuers). Adjusted mean DCAs of pre-issue period is compared with adjusted mean DCAs of the post-issue period to detect the earnings management. The results suggest that there has been earnings management prior to the rights issues. The study period is from 1993-94 to 2003-04, and the sample size is 259.