EPS dilution after SEOs and
Department of Accounting & Finance,
Indiana University-Purdue University Fort Wayne, Fort Wayne, Indiana, USA
Department of Finance Insurance and Law, Illinois State University,
Normal, Illinois, USA, and
Eugenie A. Goodwin
College of Business, University of Louisiana at Monroe,
Monroe, Louisiana, USA
Purpose – Firms are concerned about earnings per share (EPS) dilution after equity issues. The
purpose of this paper is to investigate whether ﬁrms manage upward their discretionary accruals
around seasoned equity offerings (SEOs) to mitigate the impact of dilution on reported earnings.
Design/methodology/approach – The authors employ adjusted discretionary accruals from cash
ﬂow statements, normalized by the average common equity, in the multivariate tests.
Findings – There is evidence that SEO-year discretionary accruals are the highest when
contemporaneous operating cash ﬂows are the lowest. Moreover, managers react to temporary rather
than permanent declines inoperating performance. Firms withthehighestSEO-year discretionary accruals
experience the strongest improvements in post-SEO operating cash ﬂows. In addition, investors are not
misled by the SEO-year earnings management. There is no relation between the SEO-year discretionary
accruals and post-SEO stock performance. Overall, these ﬁndings are consistent with the hypothesis that
ﬁrms manage discretionary accruals around SEOs to mitigate the effect of temporary EPS dilution.
Practical implications – The paper’s ﬁndings suggest that ﬁrms manage discretionary accruals
during the SEO year to reduce the temporary negative impact of SEOs on operating performance
measures, consistent with the EPS dilution hypothesis. Such earnings management makes earnings
smoother and more predictable, improving earnings informativeness. The ﬁndings also suggest that
misleading earnings management is not a common practice during the SEO year.
Originality/value – This paper adds to the literature questioning the evidence that managers
frequently engage in misleading earnings management around corporate events. The authors provide
an alternative explanation for earnings management around SEOs.
Keywords Cash ﬂow, Equity capital, Share values, Earnings management, Seasoned equity offerings,
Earnings per share dilution
Paper type Research paper
Graham and Harvey (2001) report that the dilution of earnings per share (EPS) is the
strongest concern of CFOswhen considering equity issues. Since the capital raised through
equity issues may initially generate lower EPS than the old capital, ﬁrms may experience
temporary declines in EPS (Graham and Harvey). Temporary declines make earnings
more volatile and lead to higher costs of capital (Francis et al., 2004). Thus, managers have
strong incentives to avoid reporting temporary changes in earnings. In Graham et al.’s
(2005) survey, 97 percent of CFOs express their preference for smooth earnings.
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Received October 2010
Revised May 2011,
Accepted December 2011
Vol. 38 No. 5, 2012
q Emerald Group Publishing Limited