Do firms mislead investors by overstating earnings before seasoned equity offerings?

I examine earnings management around seasoned equity offerings and, consistent with Rangan (J. Financial Econ. 50 (1998) 101) and Teoh et al. (J. Financial Econ. 50(1998) 63), find evidence of earnings management around the offerings. However, in contrast to their conclusions, I show that investors infer earnings management and rationally undo its effects at equity offering announcements. The investor naivete conclusion of Teoh ct al. (J. Financial Econ. 50(1998) 63) and Rangan (J. Financial Econ. 50(1998) 101) appears to be due to test: misspecification. I conclude that seasoned equity issuers' earnings management may not be designed to mislead investors, but may merely reflect the issuers' rational response to anticipated market behavior at offering announcements. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classification: G14; M41.