Earnings Quality at Initial Public Offerings

Financial reporting around the time of IPOs is consistent with listed firms reporting more conservatively than previously as private firms, consistent with the results in Ball and Shivakumar (2005). We hypothesize that IPO firms supply the higher quality financial reports demanded by public investors, who face higher information asymmetry than private investors. The market mechanisms for enforcing this demand include monitoring by internal and external auditors, boards, analysts, rating agencies, the press and other parties. Once public, firms are subject to greater regulatory scrutiny and penalties. From the point of releasing the public prospectus document onwards, IPO firms face a greater threat of shareholder litigation and regulatory action if they do not meet higher reporting standards. The evidence is overwhelmingly in favor of this hypothesis. We show that the evidence reported by Teoh, Welch and Wong (1998) in support of the alternative hypothesis, that IPO firms opportunistically inflate earnings to influence the IPO price, is unreliable for a variety of reasons. We provide cleaner evidence, from samples of U.K. and U.S. IPOs, that IPO prospectus financials are conservative by several standards. We conjecture that the types of bias we observe in conventional estimates of "discretionary" accruals occur in a broad genre of studies on earnings management around large transactions and events.

[1]  J. Jiambalvo.  Discussion of “Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC”* , 1996 .

[2]  S. Perry,et al.  Earnings management preceding management buyout offers , 1994 .

[3]  Patricia M. Dechow,et al.  Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC* , 1996 .

[4]  R. Powell,et al.  Does Operating Performance Increase Post-takeover for UK Takeovers? A Comparison of Performance Measures and Benchmarks , 2005 .

[5]  Do Managers Credibly Use Accruals to Signal Private Information? Evidence from the Pricing of Discretionary Accruals Around Stock Splits , 2003 .

[6]  Felix Oberholzer-Gee,et al.  Political Relationships, Global Financing and Corporate Transparency , 2003 .

[7]  M. Firth,et al.  Earnings Management, Corporate Governance and the Market Performance of Seasoned Equity Offerings , 2002 .

[8]  Patricia M. Dechow,et al.  DETECTING EARNINGS MANAGEMENT , 1994 .

[9]  Incentives Versus Standards: Properties of Accounting Income in Four East Asian Countries, and Implications for Acceptance of IAS , 2000 .

[10]  P. M. Fairfield,et al.  Accrued Earnings and Growth: Implications for Future Profitability and Market Mispricing , 2003 .

[11]  Harry DeAngelo,et al.  Accounting choice in troubled companies , 1994 .

[12]  Shivaram Rajgopal,et al.  Value-Glamour and Accruals Mispricing: One Anomaly or Two? , 2004 .

[13]  Ivo Welch,et al.  Earnings Management and the Long-Run Market Performance of Initial Public Offerings , 1998 .

[14]  Ashok Robin,et al.  Incentives Versus Standards: Properties of Accounting Income in Four East Asian Countries, and Implications for Acceptance of IAS , 2000 .

[15]  D. Collins,et al.  Errors in Estimating Accruals: Implications for Empirical Research , 1999 .

[16]  Charles E. Wasley,et al.  Performance Matched Discretionary Accrual Measures , 2002 .

[17]  Ashiq Ali,et al.  Country-Specific Factors Related to Financial Reporting and the Value Relevance of Accounting Data , 1999 .

[18]  Alexander J. Triantis,et al.  Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations , 2008 .

[19]  Joseph D. Piotroski,et al.  What Determines Corporate Transparency? , 2003 .

[20]  Ramgopal Venkataraman,et al.  What If Auditing Was Not 'Low-Margin Business'? Auditors and Their IPO Clients as a Natural Experiment , 2004 .

[21]  R. Ball,et al.  The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition , 2005 .

[22]  Merle Erickson,et al.  Earnings Management by Acquiring Firms in Stock for Stock Mergers , 1999 .

[23]  Shiing-wu Wang,et al.  Political Costs and Earnings Management of Oil Companies in the 1990 Persian Gulf Crisis , 1997 .

[24]  Ross L. Watts,et al.  Conservatism in Accounting - Part I: Explanations and Implications , 2003 .

[25]  J. D. Villiers.  Why New Issues and High-Accrual Firms Underperform: The Role of Analysts' Credulity , 2002 .

[26]  R. Kalra,et al.  Earnings Management and Investor Protection: An International Comparison , 2004 .

[27]  Jeffrey L. Coles,et al.  Earnings Management Around Employee Stock Option Reissues , 2006 .

[28]  Srinivasan Rangan.  Earnings management and the performance of seasoned equity offerings , 1998 .

[29]  M. Firth,et al.  Earnings Management, Corporate Governance and the Market Performance of Seasoned Equity Offerings in Hong Kong , 2006 .

[30]  David Burgstahler,et al.  The Importance of Reporting Incentives: Earnings Management in European Private and Public Firms , 2004 .

[31]  Country-Specific Factors Related to Financial Reporting and the Value Relevance of Accounting Data , 1999 .

[32]  Patricia M. Dechow.  Accounting earnings and cash flows as measures of firm performance : The role of accounting accruals , 1994 .

[33]  Martin P. Loeb,et al.  Initial Public Offerings, Accounting Choices, and Earnings Management* , 1993 .

[34]  C. Leuz,et al.  IAS Versus U.S. GAAP: Information Asymmetry–Based Evidence from Germany's New Market , 2003 .

[35]  F. T. Magiera.  Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings , 1997 .

[36]  Lakshmanan Shivakumar,et al.  Do Firms Mislead Investors by Overstating Earnings Before Seasoned Equity Offerings? , 2000 .

[37]  G. Gong,et al.  Earnings Management and Firm Performance Following Open-Market Repurchases , 2006 .

[38]  C. Leuz.  IAS versus US GAAP: Information Asymmetry-Based Evidence from Germany's New Market , 2002 .

[39]  J. Vu,et al.  Earnings Management, Stock Issues, and Shareholder Lawsuits , 2004 .

[40]  Henock Louis.  Earnings Management and the Market Performance of Acquiring Firms , 2002 .

[41]  Randolph P. Beatty,et al.  Earnings management and the underperformance of seasoned equity offerings , 1998 .

[42]  A. P. Sweeney,et al.  Debt-covenant violations and managers' accounting responses , 1994 .

[43]  John M. Friedlan,et al.  Accounting Choices of Issuers of Initial Public Offerings , 1994 .

[44]  Ross L. Watts,et al.  Conservatism in Accounting - Part Ii: Evidence and Research Opportunities , 2003 .

[45]  Michael Willenborg,et al.  Do Expert Informational Intermediaries Add Value? Evidence from Auditors in Microcap Initial Public Offerings , 2003 .

[46]  Mark L. DeFond,et al.  Debt covenant violation and manipulation of accruals , 1994 .

[47]  S. P. Kothari,et al.  The Effect of International Institutional Factors on Properties of Accounting Earnings , 1999 .

[48]  R. Watts.  A Proposal for Research on Conservatism , 2001 .

[49]  D. Collins,et al.  Errors in Estimating Accruals: Implications for Empirical Research , 1999 .

[50]  Ashok Robin,et al.  Is Accounting Conservatism Due to Debt or Equity Markets? An International Test of “Contracting” and “Value Relevance” Theories of Accounting , 2005 .

[51]  Sudipta Basu.  The conservatism principle and the asymmetric timeliness of earnings , 1997 .

[52]  J. Coffee.  The Future as History: The Prospects for Global Convergence in Corporate Governance and its Implications , 1999 .

[53]  Joseph D. Piotroski,et al.  Financial Reporting Incentives for Conservative Accounting: The Influence of Legal and Political Institutions , 2005 .

[54]  Patricia M. Dechow,et al.  The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors , 2002 .

[55]  J. Jones.  Earnings Management During Import Relief Investigations , 1991 .

[56]  R. Ball,et al.  EARNINGS QUALITY IN UK PRIVATE FIRMS: COMPARATIVE LOSS RECOGNITION TIMELINESS , 2005 .

[57]  Hong Xie.  THE MISPRICING OF ABNORMAL ACCRUALS , 2001 .