Do IPO Firms Misclassify Expenses? Implications for IPO Price Formation and Post-IPO Stock Performance

Abstract

This study investigates whether IPO firms inflate “core” earnings through classification shifting (i.e., misclassifying core expenses as income-decreasing special items) immediately prior to IPOs. We provide initial evidence that IPO firms engage in classification shifting in the pre-IPO period. Using hand-collect price and share information from IPO prospectuses, we find that pre-IPO classification shifting is positively associated with the price revision from the mid-point of the initial price range to the final offer price, suggesting that pre-IPO classification shifting influences IPO price formation. Furthermore, we find that pre-IPO classification shifting is negatively associated with post-IPO stock returns. Overall, our findings caution investors, auditors, and regulators that classification shifting, a seemingly innocuous accounting maneuver, can mislead investors in their IPO valuation and is associated with post-IPO underperformance.

Keywords: initial public offerings, classification shifting, price formation, post-IPO performance

JEL Classification: M40, M41