Abstract
We investigate earnings management (EM) in IPOs and the role of private equity/venture capital (PEVC) in hampering such practice. We show that when analyzing EM, PEVC and non-PEVC-sponsored firms should be treated as different samples: if one splits the sample, R-squared increases drastically for both subsamples. For PEVC-sponsored IPOs EM is marginal, mostly related to firms’ characteristics and little related to the phases of the IPOs. Differently, for non-PEVC-sponsored IPOs EM is significant, mostly related to the phases of the IPO and little related to firms’ characteristics. Finally, the reputation of the auditor is important only for PEVC-sponsored IPOs, suggesting that the choice of auditor is more meaningful for PEVC-sponsored firm, i.e, the choice of reputed auditor represents a compromise not to manage earnings.
Highlights
This article studies the dynamics of earnings management (EM from hereon) around the IPO and the role of venture capital in hampering such practice
3.2 PHASES OF THE IPO As our purpose is to study the dynamics of EM in IPOs, we focus on four phases around the IPO date: Pre-IPO phases: comprises the two quarterly observations that are calculated from the three balance sheets that precede the last one before the IPO
When we break the sample into private equity/venture capital (PEVC)-sponsored and non-PEVCsponsored firms, a big difference emerges: EM for PEVC-sponsored firms ranges from 2.54% to 2.96%, while for non-PEVC-sponsored ones it ranges from 4.47% to 4.82%
Summary
This article studies the dynamics of earnings management (EM from hereon) around the IPO and the role of venture capital in hampering such practice. EM is a purposeful intervention in the external financial reporting process with any intention other than to represent the reality intrinsic to the business. Not illegal, it can distort the information content of the financial statements in a way that can harm shareholders. Teoh et al (1998b) relate the poor long-term return of IPOs detected by Ritter (1991) to EM. For using annual data, these authors were unable to capture the dynamics of EM and most likely underestimated it This is so because earnings inflation and subsequent reversal can occur in the same fiscal year not being reflected in the annual reports
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