Carve-Out Earnings Quality in Corporate Spinoffs

This study examines earnings quality in carve-out financial statements prepared in spinoffs. Using accruals, I provide evidence that carve-out earnings in spinoffs are of low quality relative to the earnings of control groups. Next, I find higher quality carve-out accruals among spinoffs of segments and cross-industry spinoffs, consistent with managers using the lack of transparency involved in carve-out financial reporting to opportunistically assign lower quality accruals to newly spun-off entities. I also find that the relations between carve-out earnings quality and its determinants are moderated by investor sophistication and internal monitoring, consistent with the unique, competing reporting incentives in spinoffs. Additional results indicate that the predictive ability of carve-out earnings for post-spinoff cash flows is decreasing in the magnitude of accruals, suggesting that reduced decision usefulness is a consequence of low carve-out earnings quality. Finally, I find that the disclosure of income-decreasing carve-out accruals is associated with negative abnormal stock returns, which suggests that investors detect and price the signals that carve-out accruals provide about firm value. Overall, my results shed light on the unique financial reporting incentives in spinoffs, and the determinants and consequences of carve-out earnings quality.