We examine various penalties that could serve as enforcement mechanisms for Sarbanes-Oxley (SOX) Section 404. We focus on firms with restatements, some of which had previously reported their control weaknesses as required and some of which acknowledged them only after announcing their restatement. We find no evidence that penalties are more likely for firms, managers, or auditors that fail to report existing control weaknesses. Instead, class action lawsuits, management turnover, and auditor turnover are all more likely in the wake of a restatement when control weaknesses had previously been reported. We find similar, although weaker, evidence for Securities and Exchange Commission (SEC) sanctions. These results are consistent with disclosure of control weaknesses making it difficult for management to plausibly claim later that they were unaware of the underlying conditions that led to restatements. The results also suggest that the public and private enforcement mechanisms surrounding SOX 404 are unlikely to provide strong incentives for compliance and offer a potential explanation for why most restatements are issued by firms that previously claimed to have effective internal controls.

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We study the relation between issuer operating performance and initial public offering (IPO) price formation from the initial price range to the offer price to the closing price on the first trading day. For a post‐bubble sample of 2001–2013 IPOs, we find that pre‐IPO net income and, in particular, operating cash flow are strongly, positively associated with the revision from the mid‐point of the initial price range to the offer price and that the “partial adjustment phenomenon” concentrates among issuers with the strongest operating performance. As for why publicly observable information helps predict changes in valuation from when the initial price range is set to when the offer price is set, our findings suggest that strong‐performing issuers, especially those offering small slices of ownership, have lower bargaining incentives and are susceptible to the underwriter(s) low‐balling the price range. Overall, our results suggest an important role for accounting information in understanding the pricing of book‐built IPOs and are consistent with the presence of agency problems between issuers and underwriters.

This study investigates whether initial public offering (IPO) firms inflate “core” earnings through classification shifting (i.e., misclassifying core expenses as income-decreasing special items) immediately prior to IPOs. We provide initial evidence that IPO firms engage in classification shifting in the pre-IPO period. Using hand-collected price and share information from IPO prospectuses, we find that pre-IPO classification shifting is positively associated with a price revision from the midpoint of the initial price range to the final offer price, suggesting that pre-IPO classification shifting influences IPO price formation. Furthermore, we find that pre-IPO classification shifting is negatively associated with post-IPO stock returns. Overall, our findings caution investors, auditors, and regulators that classification shifting, a seemingly innocuous accounting maneuver, can mislead investors in their IPO valuation and is associated with post-IPO underperformance. This paper was accepted by Brian Bushee, accounting.

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An IPO is a significant event for an individual firm, and the literature examining initial public offering (IPO) firms is extensive. However, there is little evidence on the subsequent effect of a significant IPO on incumbent firms. We extend this literature by using firms’ tax policies as a powerful setting to identify whether incumbent firms respond to a significant IPO in their industry. Specifically, we use a first difference analysis to examine whether incumbent firms herd their effective tax rates (ETRs) toward a significant IPO’s ETR. We provide robust evidence that incumbent firms adjust their ETR either up or down by one to two percentage points, on average, for up to three years following a significant IPO entrance to the industry. Cross-sectional analyses support attention-based and tax-specific motives for herding, and additional analysis documents market attention-based consequences. Finally, we find that incumbents weigh the benefits of herding against the cost of adjusting their ETR and that incumbent firms use discretionary tax accruals as a less costly mechanism to imitate IPO firms’ generally accepted accounting principles (GAAP) ETRs. We contribute to an IPO literature that focuses almost exclusively on the IPO firm. We extend the literature by providing evidence that a significant IPO in an industry can result in a herding response in incumbent firms’ policy choices. This paper was accepted by Brian Bushee, accounting.

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