Abstract

http://ssrn.com/abstract=2377411
 


 



When Does Pre-IPO Financial Reporting Trigger Post-IPO Legal Consequences?


Mary Brooke Billings


New York University

Melissa Fay Lewis


University of Utah

June 23, 2014

Contemporary Accounting Research, Forthcoming

Abstract:     
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 even when ex post evidence indicates the presence of earnings inflation, litigation is more likely to occur when investors have relied on the suspect earnings during the pricing process (i.e., when pre-IPO abnormal accrual reporting opportunistically increases IPO valuation but ultimately links to disappointing post-IPO performance). Why might investors rely on some firms’ abnormal accruals when valuing the IPO and yet discount 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 these 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. Collectively, our evidence indicates that litigation in response to earnings inflation does indeed surface in the IPO setting — but only when investors need it to settle the score.

Number of Pages in PDF File: 58

Keywords: initial public offering, earnings management, litigation, IPO valuation, new economy

JEL Classification: M41, K22, G14

Accepted Paper Series


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Date posted: January 12, 2014 ; Last revised: June 24, 2014

Suggested Citation

Billings, Mary Brooke and Lewis, Melissa Fay, When Does Pre-IPO Financial Reporting Trigger Post-IPO Legal Consequences? (June 23, 2014). Contemporary Accounting Research, Forthcoming. 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)
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