Earnings Management and IPO Underpricing*

Earnings quality at initial public offerings

“…The above results are consistent with: Xiong et al (2005) who, in a sample of 284 US IPOs, find little evidence of positive pre-IPO abnormal accruals; Venkataraman et al (2004), who report significantly negative pre-IPO abnormal accruals in a sample of 113 US IPOs; and Hribar and Collins (2002) for SEOs. 35 This requirement is the principal reason for losing observations in this regression.…”

“…Large transactions studied include management buyouts (DeAngelo, 1986;Perry and Williams, 1994), initial public offerings (Aharoney et al, 1993;Friedlan 1994;Teoh et al, 1998b;Teoh and Wong, 2002;Xiong et al, 2005), seasoned equity offerings (Teoh et al, management occurs prior to large transactions and events, because managers then have unusually strong incentives to inflate reported performance. Few authors note that these settings also are characterized by higher than usual litigation and regulatory risk from inflating earnings, and higher than usual scrutiny by market monitors such as analysts, underwriters, auditors, boards, the press and other parties to the transaction, as well as by regulators.…”

The economic profitability of pre-IPO earnings management and IPO underperformance

“…However, with a few exceptions, these hypotheses have been dismissed due to either conflicting empirical evidence or the lack of sound theoretical foundations (Lowry and Murphy 2006;Drucker and Puri 2005;Xiong et al 2005). The four hypotheses listed below are the prevailing hypotheses that provide reasonable and empirically testable explanations for IPO underpricing: asymmetric-information hypothesis (Baron 1982), monopsonypower hypothesis (Ritter 1984), the signaling hypothesis (Titman and Trueman 1986), and the lawsuit avoidance hypothesis (Tinic 1988).…”

“…None of these theories consider the possibility that the initial offer prices may be correct and that the first-day run ups are due to systematic short-term overvaluation by the secondary market. A recent study (Xiong et al 2005) that proposes and tests an alternative explanation for this phenomenon, a hypothesis based on the role of earnings management as an explanation of IPO underpricing. Contrary to current beliefs, Xiong et al (2005) find that IPOs are not initially underpriced, but that instead, the commonly observed short-term run up in price is the result of unsophisticated investors in the secondary market being temporarily fooled by the pre-IPO earnings management.…”