Do Insiders Manipulate Earnings when they Sell their Shares in an Initial Public Offering?

Abstract:     
In this paper, we examine whether insider share selling in an initial public offering (IPO) influences R&D expenditures. Insiders (managers and venture capitalists) who sell their pre-offering shareholdings might try to increase the IPO offer price (i) by over-investing in R&D to signal the firm's prospects (the signaling hypothesis) or (ii) by under-investing in R&D to increase current reported earnings (the earnings-fixation hypothesis). We find that, for a sample of 243 IPOs from the years 1986-1990, change in R&D spending in the year of the IPO is negatively related to managerial selling. Because reductions in R&D spending increase current earnings at the expense of future earnings, our evidence suggests that managers believe that investors place more emphasis on current earnings and less emphasis on R&D and, therefore, spend less on R&D. We also document a positive association between discretionary current accruals in the offering year and managerial selling, suggesting that selling managers manipulate accruals as well.

Keywords: R&D spending, initial public offerings, insider selling, earnings management, accruals

JEL Classifications: G14, G31, M40, M41

Working Paper Series