Causal disclosures on earnings and earnings management in an IPO setting

Abstract

We examine the association of earnings management and narrative impression management as reflected in properties of causal explanations of reported earnings in the prospectus of Chinese IPO firms. Anticipated earnings management concerns are argued to be a significant incentive for causal disclosures on earnings in order to rationalize and legitimize earnings outcomes. We find evidence of close alignment of a firm’s earnings management propensity and its use of tactical causal disclosures. Stronger earnings management is associated with more intense assertive causal disclosure. On the other hand, firms exhibiting stronger earnings management tend to avoid the use of explicit defensive causal disclosure tactics. These findings are consistent with the strong background expectations of managerial agency and control that pervade an IPO setting. Our evidence holds after controlling for endogeneity within the context of an opportunistic disclosure position.