Santa Clara University


Beware of the Hype — Transparency and Equity Offerings

Hoje Jo
Associate Professor of Finance

When a company is approaching the date of an equity offering, it’s not unusual to see the firm’s publicity machine go into high gear. But that shift could in itself be a red flag for investors, because it often correlates with disappointing performance afterwards.

Hoje Jo, associate professor of finance and Yongtae Kim, assistant professor of accounting at SCU’s Leavey School of Business, reached that conclusion after examining 1,431 seasoned equity offerings and connecting them with over 103,000 press releases generated by the companies doing the offerings. Their paper, “Disclosure Frequency and Earnings Management," appeared in 2007 Journal of Financial Economics 84, No.2, 561-590

Hoje Jo, Associate Professor of Finance, Leavey School of Business, Santa Clara UniversityThey found that increased publicity around the time of an offering was often connected to earnings management aimed at making the investment look better than it really was. On the other hand, companies that routinely and consistently had a high level of public disclosure tended to fare better after the public offering.

“If disclosure is persistent, there’s an information pattern available to investors,” Jo said. “When a company is transparent, it’s tough to manipulate earnings.”

Jo and Kim decided to use press releases as a way of measuring disclosure because they are available for a large group of firms. They believe it is important to obtain a sufficient number of cross-sectional observations to ensure enough variation in earnings management among the sample firms.

Using the date of the offering announcement as the starting point, they worked back two years and forward two years, breaking each two-year period into six-month sections and counting the number of press releases in each six-month section.

A company that was transparent in its disclosure would be issuing a similar number of press releases in each six-month period and maintain high disclosure frequency. A company that was more opaque in its disclosure would issue a lower number of releases well before the offering, show a significant spike in press releases just prior to the offering, then revert to lower numbers in the periods afterward.

"When a company is transparent, it's tough to manipulate earnings."
—Hoje Jo, Associate Professor of Finance 

Jo said this could likely be an indication of hyping behavior, in which the company is engaging in a pattern of aggressive disclosure.

This sort of corporate behavior has been known in financial circles, but Jo and Kim carried it to another level by then following up on the companies to see how they did after the offering. The study covered offerings made between 1990 and 1997, so the results were on the record.

In order to measure earnings management, Jo and Kim looked at performance-adjusted discretionary total accruals (ADTA), which Jo said is the better measure when mechanical association between accruals and financial performance is ssuspected.

One of their key findings, which differs from the conventional wisdom, is that earnings management tends to be more acute immediately after the offering announcement, presumably because the company managers are concerned about lawsuits and agreements with the underwriters of the offering.

Jo said he hopes the results of his research will help financial analysts do a better job over time by recognizing the value of consistent corporate discloure and factoring it into their analysis. But there’s still going to be a temptation for a company to hype its stock, pre-offering, for short-term gain.

“It’s relatively easy to deceive a certain group for a short period of time,” he said, “but it’s tough to deceive a lot of people over a long period of time.”

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