Essays on earnings quality: Evidence from net share issue, put option sales, and hedging
There are three essays in this research. The main objective of the research is to extend the literature in corporate finance by investigating the quality of earnings around corporate events like net share issues, put option sales by firms on their own stock, and hedging commodities by high input cost group of firms. The first paper is "Does Earnings Quality predicts Net Share Issuance". This paper investigates whether quality of earnings predicts net share issuance by corporations. Pontiff and Woodgate (2008) show that annual share issuance (ISSUE) measure is a better predictor of future cross-sectional returns and we use this to measure the if a firm is net issuer of equity or net repurchasers. Market timing due to information asymmetry is one reason why manager issue equity when they perceive that their firms are overvalued. We use earnings quality as a measure of information asymmetry and found that the ISSUE (net equity issuance) has an inverse relationship with quality of the earnings reported by the firms. First, firms with poor (good) earnings quality have higher (lower) information asymmetry and tend to issue more (less) equity and this finding was true for a variety of earnings quality measures used in the literature. Second, firms with negative net issuance (net repurchasers) are more likely to have higher quality of earnings; this is true across all the earnings quality proxies except for one. On the contrary firms with positive net issuance (net issuers) were found to have lower quality of earnings. The second paper is "Put Option Sales and Earnings Quality: Evidence of Market Timing". This paper provides evidence that earnings quality is high for the sample of Put Option Selling (POS) firms which are actively timing the market compared to a matching sample of vii firms. We hypothesize that due to information asymmetry; managers of POS firms have additional private information and estimate their stock was mispriced (undervalued) and thus expect the stock price to increase in the near future, as a result they are less likely to manage abnormal accruals and thus resulting in higher quality of earnings. We provide additional evidence of market timing (mispricing due to undervaluation) using Residual Income Model (RIM). The third paper is "Earnings Quality: A case of Hedging Strategies by US Airlines". This paper investigates the quality of earnings in high input cost industries like transportation, coffee which are similar to Airlines. We intend to extend this study to include more industries with similar characteristics of input costs. At this stage the paper the research presents evidence on the performance of firm and quality of earnings in a small sample of US airlines around a specific regulation change. Historically jet fuel prices have fluctuated heavily, specifically over the past few years which significantly affected the US Airlines ability to maintain consistent positive cash flows. The companies used several hedging and abnormal hedging strategies to navigate these volatile periods. We analyze these strategies employed by dichotomizing them into pure hedge positions and abnormal hedging positions and calculate the effect around implementing FASB #133 / IASB #39 on firm value among other variables in each case and identify behaviors leading to these decisions. The main hypothesis is that firms which are hedging have higher quality of earnings as compared to speculating firms.
Dandu, Jagadish, "Essays on earnings quality: Evidence from net share issue, put option sales, and hedging" (2014). ETD Collection for University of Texas, El Paso. AAI3636251.