When and Why Do IPO Firms Manage Earnings?

Abstract

There is significant disagreement about whether, when and why IPO firms manage earnings. We contribute to the literature by precisely identifying the timing and motives behind earnings management by IPO firms. We emphasize that the period around IPO is characterized by two distinct events: the IPO itself and the lockup expiration. Both the raising of capital at the IPO and the large-scale exit by pre-IPO shareholders at lockup expiration approximately 180 days later create incentives for firms to manage earnings. To disentangle the effect of these events, we examine quarterly, rather than annual, abnormal accruals. We find no evidence of income-increasing earnings management before the IPO. However, IPO firms exhibit positive abnormal accruals in the quarter before and the quarter of the lockup expiration. Positive abnormal accruals are concentrated in less scrutinized firms and firms with high expected selling by pre-IPO shareholders. Our results hold after controlling for the investment of IPO proceeds in the working capital and suggest that the positive abnormal accruals in the IPO year and long-run IPO underperformance documented by Teoh, Welch and Wong (1998) are attributable to earnings management around lockup expiration.

Keywords: Earnings management, IPO, IPO lockup, abnormal accruals

JEL Classification: G10, G30, M41