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“Earnings Management and Initial Public Offerings: The Case of the Depository Industry”. Adams, Carow and Perry CFR Workshop October 25, 2006 Discussant Timothy J. Curry, FDIC . Story Line. Accounting story!

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earnings management and initial public offerings the case of the depository industry

“Earnings Management and Initial Public Offerings: The Case of the Depository Industry”

Adams, Carow and Perry

CFR Workshop

October 25, 2006

Discussant

Timothy J. Curry, FDIC

story line
Story Line
  • Accounting story!
    • Conclusion: Insiders of mutual thrift organizations (legally) shade the books in IPO offerings to extract rents!
story line1
Story Line
  • Tale of two incentives (Banks vs.Mutuals):

-Maximin vs. Minimax strategies for IPO offerings!

-banks max. gains; min. losses (best foot forward) to increase value and IPO price (“net sellers”)

-Mutual thrifts min. gains; max. losses (worse foot forward) to reduce value and limit the IPO price (“net buyers”)

story line2
Story Line
  • How do they do this?
  • Through discretionary accounting adjustments to loss provisions and loan loss reserve accounts!
  • Results: insiders make excess rents with demutualization's! First day trading returns 21.2 % for sample thrifts
general comments
General Comments!
  • Results are plausible; many historical examples of insider abuse and windfall rents at the expense of depositor/(owners) during mutual conversions; (Unal, 1997); this is a new twist;
  • All investors in thrift conversions earn rents to some extent because depositors/owners get nothing for accumulated book equity! supervisors do not permit the issuance of shares to depositors! (e.g. P/B 66.6% vs. 119.5% Table II)
  • Be circumspect using the words like “equity claim”, “equity claimants” etc.
general comments1
General Comments!
  • Data suggests that something is going on w/accounting data before thrift conversions!
  • Story is consistent with literature involving in management buyouts (Jones, 1991);(Perry and Williams (1994); develop more sources along these lines if available
  • Good start: well presented; important subject; no problem w/the modeling; straight forward approach

-

specific comments concerns
Specific Comments/Concerns!
  • Story needs more development

-Describe how conversion process works!

    • How are deals structured? How much do insiders get (10%)? depositors/owners? outsiders?
    • Role of stock options?
    • Role of the underwriter?
    • Tell us about the appraisal process?
    • What is the role of the supervisor? Gets to bless the deal?
slide8
Thrift mutual conversions:

-Incentives are to keep offering prices relatively low! All parties benefit; (insiders /depositors /investors)

-results may not necessarily be associated with accounting adjustments!

-underwriters often low ball IPO price especially for small/unknown firms to assure successful subscription offering and capture rents during subsequent trading for insiders /investors

-Stock options to insiders: keep strike price low

-Fighting a “head wind” in the model

slide9
Other issues

-Cyclical effects: sample period (1992-2003) was good period for financial institutions; 74 percent of the sample banks went public after 1994; 66 percent for mutuals. Accounting adjustments may reflect improving economy

-Segment the samples (1991-1994)- (1995-2003) to test for cyclicality of results and to see if trends hold up; time dummies may not be enough to account for changing economic conditions

slide10
Variable ((NPAt-1)/Loans))non-performing assets or loans? How defined? Differs from section to section
  • Robustness checks: What happens to IPO price during the first year? Do rents persist?
  • Where are the examiners/regulators during all of this? OTS/SEC? Learning curves?
  • How widespread is the problem? Comment
slide11
Conclusionary statements unclear:

“…detecting earning management in highly regulated industries is important because it demonstrates that to the extent earnings management is a problem, regulatory solutions may not be the answer” Explain.

  • “We believe our results shed light on whether regulators “see through” earnings management…”

Explain.