Earnings management and corporate governance around UK rights issues

This study empirically investigates the relation between corporate governance and earnings management around rights issues in the UK market. Most of the previous studies that relate earnings management to seasoned equity offerings have been conducted in the US market, which differs significantly from the UK market in terms of seasoned equity issuing activity. Typically, the US market relies on public offerings, whereas a rights issue is still the most popular way of raising seasoned equity in the UK stock market. This study examines discretionary current accruals performance, a proxy for earnings management, of offering firms in the light of their capital structure, board structure, ownership (managerial and institutional) structure, and adviser structure for a sample of 42 rights issuers, after controlling for the size of the issuer. In doing so, it analyses the types of firms that are more likely to manage earnings immediately before a rights issue. Specifically, the sample firms are divided into two groups using each of the variables of interest as the sorting variable to examine the discretionary current accruals performance across these groups. Preliminary results suggest that firms with a higher debt to equity ratio, or a lower proportion of non-executive directors, or a lower proportion of managerial ownership, are more likely to use discretionary current accruals to manipulate earnings. In addition, firms that employ non-Big-5 auditors tend to inflate reported earnings using discretionary current accruals. The results on earnings management are inconclusive when the two groups of sample firms are examined according to the shares owned by institutional investors. These results contribute to our understanding of corporate governance and have practical implications for various stakeholders. For example, investors should be careful when choosing to invest in rights issuers with a larger debt to equity ratio, a lower proportion of outside directors, and a lower proportion of managerial ownership.