Accounting Scandals in IPO Firms: Do Underwriters and VCs Help?

Abstract

This paper examines whether underwriter reputation, venture capitalist (VC) backing, and VC reputation are related to the probability that a newly public firm has serious accounting problems. We examine a sample of firms that went public during 1995-2005 and announced restatements within three years of their initial public offerings (IPOs), and a control sample of non-restating IPO firms matched by industry and IPO size. We use a variety of sources to assemble a novel dataset that includes hand-collected data on underwriters, VCs, corporate governance, executive compensation, and other IPO-firm characteristics. We use paired logistic regressions to examine how the probability of restatement by an IPO firm is related to the reputation of its lead underwriter, VC backing, and the reputation of its lead VC. We test several competing hypotheses and control for other factors that prior studies have found to be significant determinants of the probability of restatement. We find that the probability of restatement by a newly public firm is 1) consistently and positively related to the reputation of its lead underwriter, 2) negatively related to VC backing and the reputation of its lead VC in several sub-samples where misstatements are likely to be more harmful to VC reputations, and 3) negatively related to the maturity of its lead VC. The endogenous selection of a more reputable underwriter or VC backing does not appear to drive our results. Our findings suggest that VCs, especially those that are mature and reputable, have positive influence as monitors on the financial reporting quality of IPO firms, while underwriters’ concerns about generating revenue appear to override their reputational concerns.