New Debt Issues and Earnings Management

We empirically examine the influence and effects of three recognized real earnings management (REM) procedures on the debt market by investigating the bond rating decision established by analysts with respect to a firm’s new bond issue, and also by exploring REM’s influence in determining the actual market price of a firm’s new debt offerings. Extant research provides conflicting representations concerning the effects of REM techniques on equity shareholders depending on the setting and is relatively silent related to debt market participants. Our results indicate a negative association of all three REM manipulation methods examined with respect to the analyst assigned bond rating, and a positive association with the market yield of the firm’s debt issuance. This overall negative impression of firm utilization of REM techniques regarding the cost of debt is significantly moderated when the firm utilizes these techniques in order to avoid reporting a net loss or to meet analysts’ consensus earnings forecast.