earnings management - mbo副本

Paper One

Earnings ManagementBuyout Offer

Susan E. Perry , Thomas H. Williams

Earnings ManagementPreceding Management Buyout

Offer

JCCarol

TommyLiana

Joana Carla Mamauag ClarusIao Tong TongLin MaizheCao Jingya

B-B1-0015-1B-B1-0352-3B-B1-0111-2B-B2-0461-3

What is Management Buyout?

1


• Form of leveraged buy-out

• Company’s existing management team acquires a large part of the company

• Preferred exit strategy by large firms that intend to close or divest

Example of MBO – Virgin

2

Virgin Wines


• Virgin Wines’ UK business has been bought out by management as former owner Direct Wines focuses on overseas expansion

• Management team is backed by private equity funds

3


Problem?Agency Problem

• Fiduciary duty: legal duty to seek best possible price for the firm

• Self-Interest: personal motivation to seek favorable purchase price

4

Literature – DeAngelo (1986)• Sample: 64 New York and American Stock Exhange companies with

MBO proposals (1973-1982)

• Used discretionary accruals to test understated earnings in period before buyout

• Proxy for discretionary accruals is change in total accruals• H0: Δ total accruals = 0 • H1: Δ total accruals > 0

• Result did not support earnings management hypothesis

• Reason: Detailed scrutiny accompanied MBO


Literature – DeAngelo (1986)• Sample

• Too small• Large number of troubled firms• ‘Second-Offer’ firms

• Model• Assumed change in non-discretionary is 0• Does not consider firm’s economic activity in

hypothesized manipulation year (Jones, 1991)


5

Problem

6


How Do They Improve on Methodology? • More restrict criteria

• Larger sample : 175 companies ( including 96 regional and OTC companies)

• More specific period : 1981-1988

7

Test Sample Group

Methodology

Control Sample Group

Individually Match

Compare

Difference

• Test Sample Group : company had management buyout (MBO) proposals• Control Sample Group : company that don’t have MBO proposals



Methodology8

CONCERNThe different generated is not caused by manipulation of earnings management but external factors

SOLUTIONControl sample group chosen base on two criteria

• Industry (proxied by SIC)• Size (proxied by sales)


Methodology8

• Example• External factors : competition, political environment,

legal change etc.

• Reason of using two criterias• Matched companies : same industry & similar size —>

affected by similar external factors• Have comparable operating, investing, and financing

opportunity sets• Have comparable voluntary accounting choice sets

9


T-test for Paired Samples8

• Null hypothesis : mean difference = 0

• Industry : • 60% (105 companies) match on four-digit SIC codes• 14% (25 companies) match on three-digit SIC codes• 26% (45 companies) match on two-digit SIC code• conclude : two groups of companies are similar with

industry

• Size : Table 2

910


8

• conclude : two groups of companies are similar with size

9

T-test for Paired Samples11


Detect Earnings Management

8

Abnormal accruals= Total accruals – Expected accruals

Total Accruals = change in noncash working capital – depreciation expense

912

Net income – Operating Cash Flow


8913

Expected Accruals :

Abnormal Accruals :

Adjusts for non-discretionary changes in working capital accounts

Adjusts for non-discretionary depreciation expense



8914



Discussion of Results8915



Standardize each abnormal returnVip = AAip / σ(Aaip)

Summarize all the 175 abnormal accrualsZip = Σ Vip / Σ√(Ti – 3)/(Ti-5)

Year -1 Year -2N Z P Z P

MBO 175 -4.010 0.000 -0.217 0.414

Control 175 -0.898 0.185 -0.363 0.358



Strong evidence of earnings management

Political costsDebt-covenant Bonus plan

Management buyout

-0.898-4.010


8919


8920

Interest expense• $30,812 thousand dollars related to the Loss on

extinguishment of debt

• Retire 7.375% senior notes and notes due 2016 by 7.375% senior notes due 2021

• No cash effect


8921

Goodwill impairment2012 2009

- Share price decrease

Incentive for impairment

- Bankruptcy of customers- Decline in revenue- Low growth rate

Incentive for impairment


8922

April 30, 2012$15.29

Aug 2, 2012$12.22

Market is not efficient if assumption made is

correct

23


SOX, SEC Rules & Listing Standards

Audit Committee• Independence (no personal or financial ties)

• Financially literate members

• Oversee the financial reporting and audit process

24


SOX, SEC Rules & Listing StandardsManagement

• Management’s certification of financial report

• Statement of whether the buyout offer is fair to shareholders

26


SOX, SEC Rules & Listing Standards

External Auditors• Creation of PCAOB to regulate auditing profession

• Restriction of performing other non-audit services

• Audit committee oversight of external auditors

27


• The takeaway from our presentation is that earnings management prior management buyouts exist due to agency problem

• This problem cannot be fully eliminated but can further be restricted through better corporate governance

Conclusion

Q & A

~Thanks for your attention~


earnings management - mbo副本

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