Abstract
The aim of this study is to answer an important but unanswered question about manipulation of earnings before initial public offerings. Several studies have examined earnings management in IPOs. In previous studies, researchers did not examine that firms manipulating income figures have seen little underpricing or confronted with larger underpricing despite aggressive earning management. We used somewhat new proxy of earnings management to test whether approximately high degree of earnings manipulation before IPO cause larger underpricing or not. This assertion is based on asymmetric information theory in underpricing literature that claims firms with approximately high degree of earnings manipulation have increased ex-ante uncertainty. As we know from research literature, increase in ex-ante uncertainty leads to steeper price discounts. However this is despite the prevailing hypothesis that firms going public can fool the market by offering higher prices for their shares. We did not find any significant relationship between earnings management and underpricing and thus our finding is consistent with the hypothesis that suggests high degree of earnings manipulation before going public leads to little underpricing.
Highlights
Going public is one of the most common events that create an opportunity for management to offer higher prices for their firms by distorting income numbers
Some studies show that discretionary accruals as a measure of earnings manipulation has a contradictory effect on long run return of these shares
New stock is referred to stocks that were initially offered in first market and already these stocks were not trading in the Tehran Securities Exchange (TSE)
Summary
Going public is one of the most common events that create an opportunity for management to offer higher prices for their firms by distorting income numbers. Some studies show that discretionary accruals as a measure of earnings manipulation has a contradictory effect on long run return of these shares This suggests that high degree of earnings manipulation is probably a strong reason for long run underperformance of IPO firms (Teoh et al, 1998b; DuCharme et al, 2001). We expect that our results confirm the documents showing a positive association between distortion of income figures and increase of uncertainty before a public offerings This is because worsening of earning (by manipulating of earnings) causes more uncertainty about IPO firm and investors pay fewer for these firms. One of our objectives in conducting this study is to emphasize on the significance of looking into the reasons causing cross-sectional differences in the extent of earnings management in IPO firms and effects of them in forming stock prices.
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