Pre-IPO earnings management: Evidence from India

Abstract

The Indian market is characterized by a relatively large number of unsophisticated retail investors, which provides a sharp contrast to many developed markets. Indian capital markets also provide a novel environment to test pre-Initial Public Offerings (IPO) earnings management and the capital market staging hypothesis. Our dataset encompasses a long time-period (1998–2016) including pre-IPO data and an important IPO regulatory change. Specifically, Indian markets instituted optional IPO grading (2006), required IPO grading (2007), and then reverted back to optional IPO grading (2014). We find evidence that Indian IPO firms which utilize reputable investment banks are less likely to manipulate pre-IPO earnings. Harder to value firms, such as those with large amounts of research and development, are more likely to engage in pre-IPO earnings management. We also find support for the capital market staging hypothesis in India. Additionally, there is lower pre-IPO earnings management during the optional IPO grading period. Our research also has important policy implications underscoring the need for increased transparency, particularly in emerging markets.