External financing and firm operating performance

In this dissertation, I investigate the relationship between external financing, earnings management, and firm operating performance. Grounded in financial economics, I argue that information asymmetries, management self-interest, and agency issues should result in systematic associations between the magnitude and type of financing and the firms' previous and future performance. I use accounting information from publicly available financial reports from 1963 to 2002 to decompose measures of financing and empirically investigate financing-performance linkages. The use of financial statement information allows consideration of all financing activities, thereby overcoming biases potentially present in previous research which generally has focused upon one type of financing.; The empirical results show changes in firm operating performance are systematically related to the both the use and type of financing employed by the firm. In particular, future (previous) changes in operating performance are strongly negatively (positively) related to the net external financing. Further, consistent with theoretical arguments, but inconsistent with recent evidence from stock returns, equity financing is more strongly associated to performance changes than other sources of financing such as long term debt. Even within debt categories, it is found that debt instruments which are more risky or equity-like, such as convertible debt, are more strongly related to declines in operating performance, than other debt instruments, such as long term debt. The observed changes in operating performance are consistent with my conjectures both before financing (years -3 to -1), around financing (years -1 to +1), and after financing (+1 to +3).; The above results implicitly assume that accounting information is neutral. When a firm offers finance, management has incentives to perform earnings management, which through the use of discretionary accruals, artificially inflates earnings. Consistent with the earnings management conjecture, I find positive abnormal accruals before net financing, and negative abnormal accruals after financing. However, I do not find that this abnormal accrual behavior is more prevalent in equity financing firms.; Examining the persistence of earnings around net financing, I find evidence that all earnings components have lower persistence the greater the net financing of the firm. When distinguishing between equity and debt financing, I find that lower persistence in abnormal accruals is observed for net equity issuers. However, I generally find that all earnings components, including cash flows have lower persistence for net equity financiers compared to debt financiers. These results are consistent with equity financiers generally experiencing worsening performance following financing. However, the failure to observe more prevalent abnormal accrual behavior or lower persistence of abnormal accruals in equity financing firms is inconsistent with conjectured differential incentives for earnings management between debt and equity financing.; Finally, considering financing and investment decisions jointly reveals that financing-investment linkages play an important role in both the future operating performance of firms and how the market prices the firm. Overall, the empirical findings from this study demonstrate strong linkages between the operating performance of the firm and the use of external financing.