Investors’ Use of Litigation to Settle the Score in the IPO Setting

Mary Brooke Billings

New York University

Melissa Fay Lewis

University of Utah

September 1, 2013

Prior research suggests that the fear of litigation precludes most managers from manipulating earnings in the initial public offering (“IPO”) setting. Yet, managers’ restraint is perhaps unwarranted: research has not yet linked instances of aggressive pre-IPO reporting to increased litigation risk. This paper investigates when aggressive IPO reporting triggers legal consequences. Examining 2,037 IPOs, we find that pre-IPO abnormal accruals are not solely opportunistic and, even when ex post evidence indicates the presence of opportunism, litigation is more likely to occur when investors have relied on the suspect earnings during the pricing process. Why might investors rely on some firms’ abnormal accruals when valuing the IPO and yet disregard the abnormal accruals of other firms? Our analyses suggest that IPO investors incorporate abnormal accrual information into IPO prices in situations where accruals are more likely to reflect information and other sources of information to help investors make pricing decisions are lacking or are less reliable. In these situations, we find that abnormal accruals do positively correlate with future performance, validating investors’ use of this information when pricing these offerings. Yet, when ex post performance reveals that the pre-IPO abnormal accruals were in fact inflated, we find that litigation emerges to allow harmed shareholders to recover losses incurred dating back to the pricing process — importantly, investors are only harmed if they used those abnormal accruals in pricing the IPO. Taken collectively, our evidence indicates that litigation does indeed surface in the IPO setting — but only when investors need it to settle the score.

Number of Pages in PDF File: 54

Keywords: initial public offering, IPO financial reporting, securities litigation, IPO valuation

JEL Classification: M41, K22, G14

working papers series

Download This Paper

Date posted: January 12, 2014  

Suggested Citation

Billings, Mary Brooke and Lewis, Melissa Fay, Investors’ Use of Litigation to Settle the Score in the IPO Setting (September 1, 2013). Available at SSRN: http://ssrn.com/abstract=2377411 or http://dx.doi.org/10.2139/ssrn.2377411

Contact Information

Mary Brooke Billings (Contact Author)
New York University ( email )
44 West 4th Street
New York, NY NY 10012
United States
(212) 998-0097 (Phone)
Melissa Fay Lewis
University of Utah ( email )
1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States
801 585-5380 (Phone)
Feedback to SSRN

Paper statistics
Abstract Views: 157
Downloads: 56
Download Rank: 212,176

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo4 in 0.422 seconds