Credit Rating Impact on Earnings Management Around Initial Public Offerings

Journal of Business Finance and Accounting, Forthcoming

51 Pages Posted: 30 Nov 2015 Last revised: 16 Oct 2016

Date Written: October 14, 2016

Abstract

This study examines the impact of having a credit rating on earnings management (EM) through accruals and real activities manipulation by initial public offering (IPO) firms. We find that firms going public with a credit rating are less likely to engage in income-enhancing accrual-based and real EM in the offering year. The monitoring by a credit rating agency (CRA) and the reduced information asymmetry due to the provision of a credit rating disincentivise rated issuers from managing earnings. We also suggest that the participation of a reputable auditing firm is crucial for CRAs to effectively restrain EM. Moreover, we document that for unrated issuers, at-issue income-increasing EM is not linked to future earnings and negatively related to post-issue long-run stock performance. However, for rated issuers, at-issue income-increasing EM is positively associated with subsequent accounting performance and unrelated to long-run stock performance following the offering. The evidence indicates that managers in unrated firms generally manipulate earnings to mislead investors, while managers in rated firms tend to exercise their accounting and operating discretion for informative purposes.

Keywords: IPOs; Credit ratings; Earnings management

JEL Classification: G10, G14, G24, G3

Suggested Citation

Gounopoulos, Dimitrios and Pham, Hang, Credit Rating Impact on Earnings Management Around Initial Public Offerings (October 14, 2016). Journal of Business Finance and Accounting, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2696625 or http://dx.doi.org/10.2139/ssrn.2696625

Dimitrios Gounopoulos (Contact Author)

University of Bath ( email )

School of Management,
Wessex House, Claverton Down
Bath, BA2 7AY
United Kingdom

Hang Pham

University of Sussex ( email )

Falmer, Brighton BN1 9SL
United Kingdom

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