Earnings management as a response to the threat of exchange delisting

Firms are at risk of delisting if they violate a stock exchange's minimum stock price requirement. This paper investigates the extent and prevalence of opportunistic actions firms take in response to this threat. I focus on accruals and real earnings management in the form of discretionary R&D spending and asset sales. The empirical evidence is consistent with firms responding to the threat of delisting by adopting either reverse stock splits or accruals management (but not both). As hypothesized, the subgroup of firms demonstrating significantly positive discretionary accruals (the Non-RSS group) has higher stock price, better subsequent performance, and appears to be shifting earnings from the near future to the reduced stock price year. Because firms with relatively better performance manage accruals rather than implement reverse stock splits (RSS) to boost stock price, results in this paper advance the understanding of the negative market response to RSS news. Among firms that undertake reverse stock splits (the RSS group) and those that are delisted (the Delisted group), firms with tighter accruals management constraints show significant reductions in R&D spending during the reduced stock price year. Further, as hypothesized, RSS firms and Non-RSS firms enjoy higher listing benefits compared to Delisted firms.