Earnings Quality and International IPO Underpricing

Abstract

This study examines the impact of country-level earnings quality on IPO underpricing. Examining 10,783 IPOs from 37 countries, we find that IPOs are underpriced less in countries where public firms produce higher quality earnings information. This finding persists after controlling for other deal- and country-specific factors that affect IPO underpricing, and it is driven neither by the large and relatively transparent markets in the U.S. and U.K. nor by the relatively opaque Japanese market. The impact of low earnings quality on underpricing is partially offset by the use of a top-tier underwriter.

Economic freedom and IPO underpricing

“…First, IPO underpricing exists in almost all the sample economies, and that the underpricing level varies significantly across countries. Consistent with previous studies (e.g., Loughran et al, 1994, Boulton et al, 2011, the sample IPO firms from less developed countries or emerging markets tend to have much higher first-day returns than those from developed markets. For example, the average initial returns in Indonesia, Poland and Thailand are 41.27, 33.95 and 53.17%, respectively, while the average initial returns in the U.S. and the U.K. are 18.65 and 10.76%, respectively.…”

“…Unlike some previous studies that focus only on a couple of particular institutional factors, such as legal liability, price stabilization or investor protection (Hopp and Dreher, 2011;Banerjee et al, 2011;Boulton et al, 2011), we use indices of economic freedom that measure the overall institutional environment to examine its relation to IPO underpricing. As such, our analysis looks at the impact of the general institutional environment rather than specific environmental features on IPO underpricing.…”

“…More specifically, a free market makes the burden of bureaucracy and corruption smaller and provides a steady and reliable monetary environment, a free and open investment environment, a transparent and open financial system with more protection and less likelihood of government confiscation. As a whole, a free economy could help reduce the severity of asymmetric information, agency problems and transaction costs for IPO firms, which in turn reduce IPO underpricing (Rock, 1986;Ritter, 1987;Allen and Faulhaber, 1989;Brennan and Franks, 1997;Mok and Hui, 1998;Aggarwal and Conroy, 2000;Ljungqvist, 2007;Boulton et al, 2011;Ghoul et al, 2011;Boulton et al, 2014. On the other hand, economic freedom is perceived as a comprehensive proxy for institutional environment that is strongly associated with economic liberalization and property ownership protection (e.g., Henry, 2007). Holmes (2009, 2010) illustrate at least four channels through which a free economy might affect the equity costs in financial markets.…”

The Role Of Earnings Quality In Financial Analyst Forecast Accuracy

“…There is also substantial support in the literature for the notion that higher earnings quality has a positive effect on stock price. Boulton et al (2011) examine the impact of country-level earnings quality on IPO prices and find that IPOs are underpriced less in countries where public firms produce higher quality earnings information, thus highlighting the favorable effect that high earnings quality has on price. Additionally, Feng et al (2011) find that financial reporting quality positively affects investment efficiency.…”

Earnings and Cash Flows Behaviour in Indonesian Initial Public Offerings

“…In addtion, Ryan (1997), based on his survey relating accounting numbers and company risk, notes the possibility of incorporating accounting information for measuring the risk of a firm making an IPO in the absence of ex-post risk measures prior to the offering. Boulton et al (2011) assert that a number of researchers have studied the link between accounting information disclosed in the IPO prospectus and the market value of going-public firms. Principally, this strain of the literature asks whether the IPO firms manipulating their financial statements to obtain a higher share price so as to improve the initial owners' private wealth.…”