# Presentation: 002423

## “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!
- Conclusion: Insiders of mutual thrift organizations (legally) shade the books in IPO offerings to extract rents!

##  	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 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!  

- 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 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!

- 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?

- 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

- 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

- 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

- 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.