Review of Accounting Studies, 3, 209–221 (1998)
1998 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Discussion of “Are Accruals during Initial Public
M. D. BENEISH
Indiana University, Kelley School of Business
The objective of the paper, “Are Accruals during Initial Public Offerings Opportunistic?”
by Siew Hong Teoh, T. J. Wong, and Gita R. Rao (1998) (TWR, hereafter), is to investigate
earnings management as an explanation for the new issues anomaly.
I am aware of four
studies that investigate earnings management as an explanation for the puzzling behavior
of stock prices post-issuance. TWR and Teoh, Welch and Wong (1998a) study earnings
management in the context of initial public offerings (IPO), and Rangan (1998) and Teoh,
Welch and Wong (1998b) do so in the context of seasoned equity offerings.
These studies share the common approach of (i) estimating the extent of earnings man-
agement around the time of the security issuance, and (ii) correlating their earnings man-
agement estimates with post-issue earnings and returns. The evidence presented is gener-
ally consistent across studies and suggests that estimates of at-issue earnings management
are signiﬁcantly negatively correlated with subsequent earnings and returns performance.
Speciﬁcally, these studies ﬁnd that issuers with higher levels of “discretionary” accruals
have the worst subsequent earnings and stock price performance.
While the studies use similar accrual expectation models for estimating earnings manage-
ment, TWR hastwodistinguishing features. First, TWRuse theBeneish M-score as a means
of classifying ﬁrms as earnings manipulators or non-manipulators, and provide evidence
that the at-issue Beneish M-score is negatively correlated with subsequent earnings and
returns. Second, TWR examine speciﬁc earnings management in two areas—accounting
for depreciation and providing for bad debts.
I believe these features are important inasmuch as they increase the likelihood that esti-
mates of accrual management are due to the exercise of managerial discretion, independent
of changes in ﬁrm performance. The difﬁculty in disentangling the effects of perfor-
mance and discretion on accruals is the central criticism levelled at earnings management
Indeed, the study of accrual management at the time of security issuance is par-
ticularly susceptible to such criticism: issuing ﬁrms tend to be young, growth ﬁrms that
may be experiencing structural changes and they issue stocks in periods of unusually good
The results in TWR and related studies, that market participants fail to interpret the infor-
mation in accounting accruals or partitions thereof, add to recent research that has shown
that investors underutilize publicly available ﬁnancial statement information (see Ou and
Penman (1989), and Sloan (1996) among others). I ﬁnd this result compelling, but the
studies’ interpretation of their evidence as indicating that intentional earnings management