Abstract
This study examines the relationship between the extent of earnings management in a firm, the level of underpricing during an initial public offering (IPO), and their long-term performance. Earnings management has been acknowledged as a matter of concern during IPOs since long; however, its relationship with underpricing and long-term returns remained inconclusive in emerging markets like India. Using a sample of Indian IPO firms, this study finds that firms that manage accruals aggressively in the pre-IPO period have high initial returns and subsequently low stock returns in the post-IPO period. This study also observed that firms that have used abnormal accruals more conservatively while reporting earnings have better returns in the third year after IPO compared to the firms that reported more aggressively. The results are in consonance with the theory of information asymmetry and suggest that valuation of an IPO firm becomes ambiguous with high level of earnings management, which leads to higher underpricing.
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