Accounting and finance issues motivating subsidiary stock offerings

In 1983, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin 51 (SAB 51) which permitted, but did not require, companies to recognize gains or losses arising from stock issuances by their subsidiaries. Before SAB 51, the SEC had required any implicit gains arising from these types of transactions to be reported as adjustments to paid-in-capital on the consolidated balance sheet.;In this dissertation, I examine two issues related to stock offerings of consolidated subsidiaries. First, I investigate whether managers manipulated reported earnings by taking advantage of the option allowed by SAB 51 to recognize gains on subsidiary offerings. I test the following three implications of the earnings management hypothesis: (1) managers use the gains to offset a decline in earnings, (2) managers report the gains on the income statement to reduce the likelihood of violating accounting-based provisions in debt agreements, and (3) managers use a "portfolio" of accounting methods to manipulate earnings such as accruals and extraordinary items.;Second, I investigate managers' incentives to issue equity at the subsidiary level. In this part of the dissertation, I focus on finance considerations that could suggest a potential advantage to offering subsidiary equity over parent equity. In particular, a subsidiary offering may allow managers to avoid issuing shares in an undervalued parent with relatively low growth opportunities. Results from this analysis will provide a basis for inferences concerning managements' earnings objectives and the influence of the projected accounting gain on the decision to issue subsidiary stock.;My results support the conclusion that finance considerations play a role in the decision to issue stock in a consolidated subsidiary while earnings management is a factor in the manager's accounting choice of recognizing the gain on the transaction. In particular, the evidence indicates that subsidiary stock offerings provide managers with an alternative equity financing arrangement that allows them to avoid a potentially more costly offering of parent equity. Furthermore, the subsidiary stock transactions provide the added benefit of giving managers the option of recognizing a gain on the transaction. The results suggest that managers use the gain to offset nonrecurring loss items, items over which managers have discretion in the timing of their recognition.