Venture Capital and Earnings Management in IPOs

Abstract

We investigate earnings management (EM) in IPOs and the role of private equity/venture capital (PEVC) in hampering such practice. We show that in terms of EM, PEVC and non-PEVC-sponsored firms should be treated as different samples: when we split the sample, R-squared increases drastically for both subsamples. EM in PEVC-sponsored IPOs is marginal while in non-PEVC-sponsored ones it is large. For PEVC-sponsored IPOs, the phases of the IPO are only marginally significant to explain EM while firms’ characteristics are highly statistically significant. In contrast, for non-PEVC-sponsored ones, the phases of the IPO are highly statistically significant and firms’ characteristics are only marginally statistically significant. Finally, only for PEVC-sponsored IPOs the reputation of the auditor is important to explain EM. This suggests that either auditors are more effective to control EM in those firms or, alternatively, that the choice of auditor is more meaningful for PEVC-sponsored firm, suggesting that the choice of a highly reputed auditor is a compromise not to manage earnings.

Keywords: earnings management, IPO, venture capital, private equity

JEL Classification: G24, G30, M41