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Earnings Management Prior to Initial Public Offerings and Its Effect on Firm Performance: International Evidence

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  • Arjan Premti

Abstract

This paper investigates the degree of discretionary current accruals (DCA-1) prior to the initial public offerings (IPOs) of foreign firms in an attempt to study the two seemingly opposing views of Teoh, Welch, and Wong (1998) and Ball and Shivakumar (2008) in regards to pre-IPO earnings management. By analyzing a sample of 4962 IPOs from 28 countries, I find that, on average, IPO firms do not report significantly positive DCA-1. This result supports the view held by Ball and Shivakumar that IPO firms do not engage in earnings management and it is inconsistent with the earnings management hypothesis of Teoh et al. (1998). Furthermore, results support the criticism of Ball and Shivakumar (2008) that the use of discretionary accruals in the IPO year (DCA0) is a biased measure of earnings management. However, consistent with the hypothesis of Teoh et al. (1998), results show that firms with higher discretionary accruals (DCA-1 or DCA0) underperform in the long run. The negative relationship between the long-term performance and the level of DCA is robust to several measures of long-term performance (cumulative abnormal returns-CAR, buy-and-hold abnormal returns-BHAR, Fama-French 4-factor model-Alpha), to several time horizons (3 and 5 years), and holds even after controlling for several firm characteristics. Overall, the results show that although on average IPO firms don¡¯t engage in earnings management, the ones that do, underperform in the long run.

Suggested Citation

  • Arjan Premti, 2013. "Earnings Management Prior to Initial Public Offerings and Its Effect on Firm Performance: International Evidence," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 4(3), pages 10-24, July.
  • Handle: RePEc:jfr:ijfr11:v:4:y:2013:i:3:p:10-24
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    File URL: http://www.sciedu.ca/journal/index.php/ijfr/article/view/2970/1750
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    File URL: http://www.sciedu.ca/journal/index.php/ijfr/article/view/2970
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    References listed on IDEAS

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    1. Jegadeesh, Narasimhan & Weinstein, Mark & Welch, Ivo, 1993. "An empirical investigation of IPO returns and subsequent equity offerings," Journal of Financial Economics, Elsevier, vol. 34(2), pages 153-175, October.
    2. Chemmanur, Thomas J. & He, Jie, 2011. "IPO waves, product market competition, and the going public decision: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 101(2), pages 382-412, August.
    3. Ibbotson, Roger G., 1975. "Price performance of common stock new issues," Journal of Financial Economics, Elsevier, vol. 2(3), pages 235-272, September.
    4. Mario Levis, 1993. "The Long-Run Performance of Initial Public Offerings: The UK Experience 1980-1988," Financial Management, Financial Management Association, vol. 22(1), Spring.
    5. Ritter, Jay R, 1991. " The Long-run Performance of Initial Public Offerings," Journal of Finance, American Finance Association, vol. 46(1), pages 3-27, March.
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