Looking Attractive until You Sell: Earnings Management, Lockup Expiration, and Venture Capitalists

Abstract

Earnings management occurs when managerial discretion allows managers to influence reported earnings and thus mislead some investors about the underlying economic performance and quality of the firm. This study considers how potential investors may guard against earnings management by observing negative stock price reaction at the lockup expiration period of initial public offering (IPO) firms as a negative signal. Findings from a sample of 160 newly public firms show that earnings management behaviour is stronger in IPO firms backed by venture capitalists (VCs). Moreover, VC reputation negatively moderates this relationship such that IPO firms backed by reputable VCs are less likely to manage earnings, suggesting that reputable VCs serve an auditing function following an IPO. Overall, we provide insights into signalling theory by examining negative signals arising from the behaviour of multiple agents in an IPO firm.

Toward a Cognitive View of Signalling Theory: Individual Attention and Signal Set Interpretation

“…The communication of signals is vital in the organizational domain. Recognizing this importance, researchers have made considerable progress to further our understanding of organizational signalling (Busenitz et al, ; Certo, ; Miller and del Carmen Triana, ; Nam et al, ; Ozmel et al, ; Plummer et al, 2016; Stuart et al, ). By extending this work to the signal receiver and conceptualizing the cognitive processes associated with signal attention and signal set interpretation, we move the literature forward in important ways.…”

“…As signalling theory has been applied to the organizational realm, the perspective has provided many rich insights, emerging as a mainstream theory in organizational studies (see Allison et al, 2013;Busenitz et al, 2005;Certo, 2003;Jones et al, 2014;Miller and del Carmen Triana, 2009;Nam et al, 2014;Park and Patel, 2015;Plummer et al, 2016;Reuer et al, 2012;Stuart et al, 1999). Specifically, because of the high levels of uncertainty and information asymmetry surrounding organizations (particularly emerging growth ventures), scholars have applied signalling theory logic to advance the idea that signals can be used as a mechanism for differentiating firms' quality.…”

The Impact of Board Internationalization on Earnings Management

“…As earnings management involves an inherently unobservable process (Nam, Park & Arthurs, 2014), we use discretionary accruals to detect the level of earnings management (Klein, 2002;Srinidhi et al, 2011). After controlling for several variables associated with earnings management, we find that the presence of a non-Nordic, foreign director is associated with significantly higher levels of earnings management, favoring the notion that these foreign directors are less effective monitors.…”

How Does Ambiguity Influence IPO Underpricing? The Role of the Signalling Environment

“…Likewise, prior performance can be used as a screening criterion for business viability of an IPO firm. In contrast, greater venture capital ownership indicates a greater incentive to ‘unload’ the stocks to meet the venture capital firm's performance goals and therefore would lead to greater underpricing (Arthurs et al, ; Nam et al, ). We measured venture capital ownership as a percentage of equity ownership by VCs.…”