Debt Issuance and Engagement in Earnings Management for U.S. Public Firms: A Study of Occurrence and Market Reactions From a Heterogeneous Debt Perspective

Abstract

This thesis analyzes the relationship between earnings management and debt issuance and further addresses to what extent the market is able to detect earnings being managed in conjunction with debt issuance. It contributes to existing literature by addressing this from a heterogeneous debt perspective, looking at subcategories of loans and bonds. We draw on relevant existing literature on debt and capital structure, credit rating distributions, detection of earnings management and cumulative abnormal returns. The thesis is based on U.S. public firms for 1996-2020, and variations of the Modified Jones model with ROA are used to detect earnings management. Additional econometric specifications are added to the original model in an attempt to increase the reliability of the model. Further, debt and capital structure regressions and event studies on issuance of different debt types construct the basis for our analysis. Debt and capital structure regressions indicate a strong relationship between debt issuance and proxies for engagement in earnings management, with clear differences between the different types of debt. Our event studies indicate that the market is not able to detect firms' engagement in earnings management in conjunction with debt issuance. Additionally, there are clear differences in market reactions for the different types of debt. Our findings suggest that debt heterogeneity should be emphasized to a greater extent for future research investigating the relationship between debt and earnings management.