Earnings management and insider trading around seasoned equity offerings

Given the information asymmetry between insiders and investors involved in SEO regarding the firm's plans on how to invest the proceeds from the SEO and the consequent effect on firm's value, insiders have an opportunity to engage in profitable insider trading. This, in turn, provides the market with a signal on firm's intentions. In this study, I examine a sample of 1555 firms that conducted SEOs in the 1987 to 2005 period and their insiders' trading pattern. I find that firms engage in aggressive earnings management to inflate reported earnings. Insiders of SEO firms exhibit the contrarian pattern of trading as shown by my findings of upwards earnings management for value firms. The market is aware of the importance of the insider trading signal. Still, insider trading patterns before and after the SEO year suggest that the market is unable to value the firm correctly. The Sarbanes-Oxley Act of 2002 decreased the scope of earnings management by SEO firms.