Earnings Management Around Reverse Stock Splits

• In Event: Earnings Management and Professional Judgment

Abstract

Using a sample of 1,258 reverse stock splits during 1988 to 2019, we contrast earnings management by firms that initiate reverse splits for different reasons. Previous studies have suggested that firms in different price ranges have different motivations behind reverse stock splits. Therefore, we use pre-split prices to separate the sample in three groups. We examine whether firms use reverse stock splits and earnings management as substitutes or complements. Particularly, we hypothesize that firms facing the threat of delisting are likely to use earnings management and reverse stock splits as complements. Consistent with the hypothesis, we document a strong positive association between reverse stock splits and post-split discretionary accruals for firms with high delisting risk. We find no such association for the other two groups. Our findings have two important implications for investors: (i) firms with different motives behind reverse splits exhibit different earnings management behavior, and (ii) firms that are likely facing exchange delisting use discretionary accruals management in complement to reverse stock splits.

Authors

• Yuan Shi, Penn State University - Great Valley

• Shrikant Jategaonkar, Southern Illinois University Edwardsville

• Xiaoxiao Song, Southern Illinois University Edwardsville