Do Insiders Manipulate Earnings When They Sell Their Shares in an Initial Public Offering?

In this article we examine whether insider share selling in an initial public offering (IPO) influences R&D expenditures. Insiders (managers and venture capitalists) who sell their pre-offering shareholdings might try to increase the IPO offer price (1) by overinvesting in R&D to signal the firm`s prospects (the signaling hypothesis) or (2) by underinvesting in R&D to increase current reported earnings (the earnings fixation hypothesis). We find that, for a sample of 243 IPOs from 1986 to 1990, change in R&D spending in the year of the IPO is negatively related to managerial selling. Because reductions in R&D spending increase current earnings at the expense of future earnings, our evidence suggests that managers believe that investors place more emphasis on current earnings and less emphasis on R&D and therefore spend less on R&D. We also document a positive association between discretionary current accruals in the offering year and managerial selling, suggesting that selling managers manipulate accruals as well.

[1]  Lars Stole,et al.  Do Short‐Term Objectives Lead to Under‐ or Overinvestment in Long‐Term Projects? , 1993 .

[2]  Kenneth A. Froot.  Consistent Covariance Matrix Estimation with Cross-Sectional Dependence and Heteroskedasticity in Financial Data , 1989, Journal of Financial and Quantitative Analysis.

[3]  Paul A. Gompers,et al.  The Use of Covenants: An Empirical Analysis of Venture Partnership Agreements , 1996, The Journal of Law and Economics.

[4]  Lawrence Olson,et al.  Specification and Estimation of a Simultaneous-Equation Model with Limited Dependent Variables , 1978 .

[5]  P. Schultz,et al.  Unit initial public offerings *1: A form of staged financing , 1993 .

[6]  R. Hubbard,et al.  Capital-Market Imperfections and Investment , 1997 .

[7]  A. Jaffe,et al.  Effect Of Liquidity On Firms' R&D Spending , 1993 .

[8]  William L. Megginson,et al.  Signal Power of Technological and Financial Variables in Venture Capital , 2001 .

[9]  Ron Kasznik.  On the Association between Voluntary Disclosure and Earnings Management , 1996 .

[10]  Bharat A. Jain,et al.  The Post-Issue Operating Performance of IPO Firms , 1994 .

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

[12]  W. W. Muir,et al.  Regression Diagnostics: Identifying Influential Data and Sources of Collinearity , 1980 .

[13]  Paul A. Gompers,et al.  The Role of Lock-ups in Initial Public Offerings , 2001 .

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

[15]  Charles P. Himmelberg,et al.  R&D and internal finance: a panel study of small firms in high-tech industries , 1994 .

[16]  Philip G. Berger.  EXPLICIT AND IMPLICIT TAX EFFECTS OF THE RESEARCH-AND-DEVELOPMENT TAX CREDIT , 1993 .

[17]  Josef Lakonishok,et al.  The Stock Market Valuation of Research and Development Expenditures , 1999 .

[18]  W. Mikkelson,et al.  Ownership and operating performance of companies that go public , 1997 .

[19]  Paul A. Gompers,et al.  The Role of Lockups in Initial Public Offerings , 2003 .

[20]  Brett Trueman.  The Relationship between the Level of Capital Expenditures and Firm Value , 1986, Journal of Financial and Quantitative Analysis.

[21]  Xiao-Jun Zhang,et al.  Accounting Conservatism, the Quality of Earnings, and Stock Returns , 1999 .

[22]  W. Beaver,et al.  Do Firms Issuing Equity Manage Their Earnings? Evidence from the Property-Casualty Insurance Industry , 2000 .

[23]  Kenneth A. Froot.  Consistent Covariance Matrix Estimation with Cross-Sectional Dependence and Heteroskedasticity in Cross-Sectional Financial Data , 1990 .

[24]  Lung-fei Lee,et al.  Asymptotic Covariance Matrices of Two-Stage Probit and Two-Stage Tobit Methods for Simultaneous Equations Models with Selectivity , 1980 .

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

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

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

[28]  Kent L. Womack,et al.  Strategic IPO Underpricing, Information Momentum, and Lockup Expiration Selling , 2001 .

[29]  W. D. Bondt,et al.  R&D budgets and corporate earnings targets , 1998 .

[30]  Siew Hong Teoh,et al.  Are Accruals during Initial Public Offerings Opportunistic? , 1998 .

[31]  Baruch Lev,et al.  R&D Reporting Biases and Their Consequences , 2004 .

[32]  A. Jaffe.  Technological Opportunity and Spillovers of R&D: Evidence from Firms&Apos; Patents, Profits and Market Value , 1986 .

[33]  M. Nadiri,et al.  Interindustry R&D Spillovers, Rates of Return, and Production in High-Tech Industries , 1988 .

[34]  Ashutosh Kumar Singh,et al.  Underwriter Reputation, Initial Returns, and the Long‐Run Performance of IPO Stocks , 1998 .

[35]  Maurice D. Levi,et al.  Errors in the Variables Bias in the Presence of Correctly Measured Variables , 1973 .

[36]  H. White.  A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity , 1980 .

[37]  Jeremy C. Stein,et al.  Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior , 1989 .

[38]  Akhtar Siddique,et al.  An Examination of Long-Term Abnormal Stock Returns and Operating Performance Following R&D Increases , 2004 .