The employees’ self-interest and the underwriter reputation effects

Purpose - – Prior research on underwriter reputation treats underwriters as the unit of analyzing, while the purpose of this paper is to analyze underwriter reputation effects after introducing discretion of underwriters’ employees. Specially, this paper investigates the damage on underwriter reputation effects when underwriters’ employees tolerate issuers’ earnings management for their self-interest. Design/methodology/approach - – In 2004, a Chinese security regulation introduced two professional employees from the lead underwriter, known as sponsors, to work as individual financial intermediaries. This paper tests whether the ability of reputable underwriters in restraining issuers from manipulating earnings decreases after the 2004 regulation, given that the regulation encourages sponsors to exchange for their private benefits by ignoring issuers’ earnings management. Findings - – The inverse relation between underwriter reputation and issuers’ earnings management is weakened after the 2004 regulation, especially when underwriters do not employ enough sponsors. Sponsors who have tolerated issuers’ earnings management will win more business in the following years. The influence of underwriter reputation on issuers’ underpricing and post-initial public offering performance is also less significant after the regulation. Originality/value - – This work extends literatures on underwriter reputation from a completely different aspect that emphasizes the self-interest of underwriters’ employees. This paper also has direct policy implications for regulators, especially in the current reform climate that Chinese government is trying to carry out the Registration System.