Abnormal Accruals in Newly Public Companies: Opportunistic Misreporting or Economic Activity?

Management Science, Forthcoming

48 Pages Posted: 18 Jun 2008 Last revised: 6 Feb 2015

See all articles by Chris Armstrong

Chris Armstrong

University of Pennsylvania - Accounting Department

George Foster

Stanford Graduate School of Business

Daniel J. Taylor

Wharton School, University of Pennsylvania

Date Written: February 4, 2015

Abstract

Newly public companies tend to exhibit abnormally high accruals in the year of their initial public offering (IPO). Although the prevailing view in the literature is that these accruals are caused by opportunistic misreporting, we show that these accruals do not appear to benefit managers and instead result from the normal economic activity of newly public companies. In particular, and in contrast to the notion that managers benefit from inflating accruals through an inflated issue price, inflated post-IPO equity values, and increased insider trading profits, we find no evidence of a relation between abnormal accruals and these outcomes. Instead, consistent with these accruals resulting from normal economic activity, we find that these accruals are attributable to the investment of IPO proceeds in working capital and that controlling for the amount of IPO proceeds invested in working capital produces a more powerful accrual-based measure of misreporting.

Keywords: Misreporting; Earnings Management; Financial Reporting Quality; Accruals; Incentives; Insider Trading; Initial Public Offering; New Issues Puzzle; Investment

JEL Classification: M41; G14; G24; G34; K22; L25

Suggested Citation

Armstrong, Chris S. and Foster, George and Taylor, Daniel, Abnormal Accruals in Newly Public Companies: Opportunistic Misreporting or Economic Activity? (February 4, 2015). Management Science, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1147328 or http://dx.doi.org/10.2139/ssrn.1147328

Chris S. Armstrong (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

George Foster

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-2812 (Phone)
650-725-7979 (Fax)

Daniel Taylor

Wharton School, University of Pennsylvania ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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