The Sharpest Tool in the Tool Shed: Simultaneous Equations of Financial Statement Management Tools during IPOs

Abstract:     
In this paper, we use a simultaneous equation approach to re-examine the question as to whether and how firms from different sectors manage financial statement items during initial public offerings (IPO). By using simultaneous equations, we show that managers do not consider the different types of financial statement management (i.e., earnings, sales and research and development (R&D) management) in isolation, but rather trade off and prioritize among these various items (“tools”) based on the costs and benefits unique to their sector. Once accounting for the endogeneity among these tools, we find that IPO firms in general do not manage earnings, but do manage sales and R&D. Moreover, we provide novel evidence that managers are often willing to sacrifice reported income in order to report higher revenue growth, or higher investment in R&D. By using more conceptually sound empirical modeling, this paper demonstrates that taking account of simultaneity is critical, as it affects inferences about management choices by IPO firms.

Number of Pages in PDF File: 55

Keywords: Initial Public Offering, Discretionary Financial Reporting Tools, Simultaneous Equations

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