Discussion of ‘‘Earnings management of seasoned

equity offerings in Korea’’

Trevor Wilkins

Department of Finance and Accounting, National University of Singapore,

15 Lawlink, Singapore 117591, Singapore

Accepted 31 December 2001

1. Introduction

This discussion tries to avoid any overlaps with the discussion by Chambers and Myers.

The paper by Yoon and Miller investigates whether Korean firms making seasoned equity

offerings (SEOs) during the 1995–1997 period manage earnings in the year preceding the

one in which they contemplate making the SEO. The authors rely primarily on prior U.S.

literature and models that have performed reasonably well using U.S. data to develop and test

their propositions. The results of their study are generally not consistent with this prior U.S.

evidence, particularly the goodness-of-fit performance of the modified Jones model (Dechow,

Sloan, & Sweeny, 1995), and the operating performance of the SEO firms in the periods

following SEOs (see, for example, Teoh, Welch, & Wong, 1998).

This discussion of the paper focuses on two main issues: (a) additional discussion of the

accounting literature that focuses on the motivations and characteristics of firms that manage

earnings to obtain external financing at the most favorable terms, and (b) suggestions for how

this paper and future multicountry research that investigates issues already investigated in one

country could possibly make a greater contribution to the theory and literature by examining

relevant institutional differences between the respective countries. The discussion also briefly

comments on the interpretation of the results of the Korean SEO firms’ operating per-

formance in the periods following SEOs, and the Korean stock market reactions to discre-

tionary accruals.

0020-7063/02/$ – see front matter D 2002 University of Illinois. All rights reserved.

PII: S0020 -7063 (02 )00145 -0

E-mail address: f batw@nus.edu.sg (T. Wilkins).

The International Journal of Accounting

37 (2002) 85–88

2. Accounting literature

The earnings management literature has long maintained that the desire to obtain external

financing at the most favorable terms creates incentives for management to manage earnings

(e.g., Dechow et al., 1995; Jiambalvo, 1996). For example, Dechow et al. (1995, p. 1) present

evidence that ‘‘an important motivation for earnings manipulation is the desire to attract

external financing at low cost.’’ SEOs thus create excellent incentives; such firms want the

market to pay as much as possible for the securities to be issued. And the stronger the incen-

tives, the more likely some forms of earnings management will occur. Burgstahler and Dichev

(1997) also find that firms with poor economic performance have greater, and possibly

different, incentives to manage earnings than firms exhibiting strong economic performance.

Dechow et al. (1995) also find that controlling for financial performance is important to

examining earnings-management behavior. Consistent with this literature, Yoon and Miller

hypothesize and present evidence that Korean SEO firms manage earnings in the year pre-

ceding the year in which they contemplate SEOs, especially when their operating performance

is poor or the offer-size is large.

Other relevant literature suggests there are additional factors that influence earnings man-

agement behavior. For example, McNichols, Wilson, and DeAngelo (1988) and Kinnunen,

Kasanen, and Niskanen (1995) present evidence that earnings-management behavior differs

across industries. Dechow et al. (1995) also identify ownership as a relevant characteristic:

firms that manipulate earnings tend to be closely held. Carlson and Bathala (1997) also report

on ownership differences and firm income-smoothing behavior. However, apart from footnote

25 stating, ‘‘traditionally, more shares are held by individual investors than by institutional

investors in Korea,’’ Yoon and Miller do not provide any evidence about the ownership of the

Korean SEO firms.

Another possibly relevant empirical finding is that of Aharony, Lin, and Loeb (1993),

which finds little evidence of earnings management prior to initial public offerings. Whether

the same evidence holds for Korean initial public-offering firms could be of some interest in

explaining the inconsistent results for Korean SEO firms.

3. Institutional differences between the United States and Korea

Similar studies undertaken in different regulatory and financial reporting environments

would likely make a greater contribution to the literature if important institutional differences

could be identified. This is particularly so when the results obtained are different from the prior

research. Yoon and Miller (footnote 12, p. 13) find that the modified Jones model (Dechow et

al., 1995), which has performed reasonably well in estimating discretionary accruals in many

prior studies undertaken in the United States, exhibits little explanatory power in explaining

total accruals of Korean SEO firms during the 1993–1997 period. However, their paper does

not elaborate on any of the accounting or other relevant differences between the Korean and

U.S. financial-reporting environments during the period of their study that could possibly

explain this inconsistency. It alludes (p. 1) only to the ‘‘less stringent financial-reporting

T. Wilkins / The International Journal of Accounting 37 (2002) 85–8886

environment including lenient audit opinions and a lack of general oversight functions,’’ and

discusses some ‘‘notable changes’’ after the 1997 financial crisis.

There are two ways that differences in these respective U.S. and Korean financial reporting

environments could contribute to explaining differences in the explanatory variables and

consequent performance of the test models in such studies. First, there are likely differences

in the interpretation and implementation of the accounting rules and standards that could

result in ‘‘more liberal’’ revenue recognition, amortization, provision, write-off, etc. practices,

together with auditor concurrence, in Korea. Second, there are some particular differences in

the accounting standards that would likely result in significant differences in some of the

model variables. For example, the practice of permitted discretionary revaluation of non-

current assets (banned in the United States by the SEC since 1933), affects the reported

amounts of the variables ‘‘noncash expenses such as depreciation,’’ ‘‘rate of growth in gross

property, plant and equipment,’’ and ‘‘total assets at the beginning of the period.’’ Some

empirical examination of the extent to which such differences affect the explanatory varia-

bles could possibly explain differences in the performance of the modified Jones model in

the two countries.

4. Additional remarks

The study was undertaken in the period preceding the Asian financial crisis, a period of

very high growth in reported firm incomes and stock prices. It is possible that the inconsistent

empirical finding that Korean SEO firms did not perform poorly in the periods following

SEOs as compared to U.S. firms that experience poor operating performance after the stock

issuance is attributable to this factor, rather than Korean SEO firms’ ability to ‘‘manage

earnings to successfully implement their SEO plans, . . . [and] still perform adequately in

future years’’ (p. 29). Similarly, this pre-Asian financial crisis time period of the study implies

that caution must be exercised in interpretation of the (consistent with U.S. evidence) finding

that the stock market reacts positively to net income but negatively to discretionary accruals.

5. Conclusion

The authors’ motivation for this study is to investigate whether Korean SEO firms manage

earnings in the year preceding the issue of seasoned equity stocks. The study relies on prior

U.S. literature and test methods, but subsequently finds inconsistencies in the explanatory

power of the modified Jones model used in many prior U.S. studies and in some of the em-

pirical results. From an academic–accounting viewpoint, the paper could possibly make a

greater contribution if the authors focused on identifying institutional differences between the

U.S. and Korean financial-reporting environments, particularly those accounting differences

that relate to the explanatory variables in the models used. Similarly, caution should be exer-

cised in the interpretation of the results, and the paper in its present form would be of limited

use to practitioners and regulators.

T. Wilkins / The International Journal of Accounting 37 (2002) 85–88 87

References

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Journal of Accounting and Economics, 24, 99–126.

Carlson, S. J., & Bathala, C. T. (1997, March). Ownership differences and firms income smoothing behavior.

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Dechow, P. M., Sloan, R., & Sweeney, A. (1995, April). Detecting earnings management. Accounting Review, 70,

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offerings. Journal of Financial Economics, 50, 63–99.

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