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Do IPO Firms Misclassify Expenses? Implications for IPO Price Formation and Post-IPO Stock Performance

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  • Xiaotao (Kelvin) Liu

    (D’Amore-McKim School of Business, Northeastern University, Boston, Massachusetts 02115; Division of Economic and Risk Analysis, Securities Exchange Commission, Washington, D.C. 20549)

  • Biyu Wu

    (School of Accountancy, College of Business, University of Nebraska-Lincoln, Lincoln, Nebraska 68588)

Abstract

This study investigates whether initial public offering (IPO) firms inflate “core” earnings through classification shifting (i.e., misclassifying core expenses as income-decreasing special items) immediately prior to IPOs. We provide initial evidence that IPO firms engage in classification shifting in the pre-IPO period. Using hand-collected price and share information from IPO prospectuses, we find that pre-IPO classification shifting is positively associated with a price revision from the midpoint of the initial price range to the final offer price, suggesting that pre-IPO classification shifting influences IPO price formation. Furthermore, we find that pre-IPO classification shifting is negatively associated with post-IPO stock returns. Overall, our findings caution investors, auditors, and regulators that classification shifting, a seemingly innocuous accounting maneuver, can mislead investors in their IPO valuation and is associated with post-IPO underperformance.

Suggested Citation

  • Xiaotao (Kelvin) Liu & Biyu Wu, 2021. "Do IPO Firms Misclassify Expenses? Implications for IPO Price Formation and Post-IPO Stock Performance," Management Science, INFORMS, vol. 67(7), pages 4505-4531, July.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:7:p:4505-4531
    DOI: 10.1287/mnsc.2020.3684
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