When and Why Do IPO Firms Manage Earnings?

Abstract

We provide new evidence on the timing and motives behind earnings management by IPO firms. The period around IPOs is characterized by two distinct events: the IPO itself and the lockup expiration. Both the raising of capital at the time of the IPO and the large-scale exit by pre-IPO shareholders at lockup expiration approximately 180 days later create incentives for firms to engage in earnings management. To disentangle the effect of these two events, we examine quarterly, rather than annual, abnormal accruals. We find no evidence of income- increasing earnings management in anticipation of the IPO. However, IPO firms exhibit positive abnormal accruals in the quarter before and the quarter of the lockup expiration. We demonstrate that positive abnormal accruals are concentrated in firms for which we predict intense selling by pre-IPO shareholders at lockup expiration. We also confirm the findings of Teoh, Welch and Wong (1998) that positive abnormal accruals are associated with long-run IPO underperformance.