Abstract
The informativeness of financial reports has been of a great importance to both investors and academics. Earnings are crucial for evaluating future prospects and determining company value, especially around milestone events such as initial public offerings (IPO). If investors are misled by manipulated earnings, they could pay too high a price and suffer losses in the long-term when prices adjust to real value. We provide new evidence on the relationship between earnings management and the long-term performance of IPOs as we test the issue with a methodology that has not been applied so far for issues in Poland. We use a set of proxies of earnings management and test the long-term IPO performance under several factor models (CAPM, and three extensions of the Fama-French model). Aggressive IPOs perform very poorly later and earn severe negative stock returns up to three years after going public. The difference in returns in accrual quantiles is statistically significant in almost half of methodology settings. The results seem to suggest that investors might not be able to discount pre-IPO abnormal accruals and could be overoptimistic. Once the true earnings performance is revealed over time, the market makes downward price corrections.
Highlights
Financial statements are a very important source of information for stakeholders
The key objective of this research is to assess whether the long-term performance of initial public offerings in Poland differs systematically according to the magnitude of around-the-issue earnings management
We examine whether the long-term performance of initial public offerings (IPO) in Poland differs systematically according to the magnitude of earnings management
Summary
Financial statements are a very important source of information for stakeholders. Managerial discretion in reporting has both benefits and disadvantages. Managers should use their unique knowledge to make financial statements more informative. Following a high information asymmetry between issuers and investors of initial public offering (IPO) companies at the time of the going public, investors rely heavily on financial statements. IPO firms have an opportunity to manage earnings as usually little is known about market newcomers. They have incentives to do so as the moment of going public is a very important event that attracts a lot of attention
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