Earnings Management in IPOs: Moral Hazard or Signaling?

53 Pages Posted: 4 Jun 2020 Last revised: 29 Jun 2021

See all articles by Yun Dai

Yun Dai

Lingnan College, Sun Yat-Sen University

Jiahua Zhu

Ma Yinchu School of Economics

Te Bao

Nanyang Technological University (NTU) - Division of Economics

Date Written: June 17, 2021

Abstract

This paper sheds light on the long-standing debate between the opportunistic and information perspectives of earnings management based on a controlled laboratory experiment. We find that low-earnings firms manage earnings more than high-earnings firms, which favors the moral hazard explanation over the one based on the signaling motive. When we introduce a limit on the degree of earnings management (i.e., as a proxy for regulatory power, such as accounting standards, litigation regulations, and reversals in earnings management), earnings management acts more similar to a signaling device. In the treatments with limit, the reported earnings become a more informative indicator of actual earnings, as low-earnings firms reduce earnings inflation, while high-earnings firms increase upward earnings manipulation. Consequently, market pricing efficiency improves, leading to better investor protection. Our findings highlight the importance of accounting regulation as a tool for enhancing the market quality and protecting investor interest.

Keywords: G14, M41, D82

JEL Classification: Earnings management, IPO, Moral hazard, Signaling, Experimental finance

Suggested Citation

Dai, Yun and Zhu, Jiahua and Bao, Te, Earnings Management in IPOs: Moral Hazard or Signaling? (June 17, 2021). Available at SSRN: https://ssrn.com/abstract=3595030 or http://dx.doi.org/10.2139/ssrn.3595030

Yun Dai

Lingnan College, Sun Yat-Sen University ( email )

Guangzhou
China

Jiahua Zhu

Ma Yinchu School of Economics ( email )

92, Weijin Road
Nankai District
Tianjin, Tianjin 300072
China

Te Bao (Contact Author)

Nanyang Technological University (NTU) - Division of Economics ( email )

HSS 04-53, 14 Nanyang Drive
Singapore, 639798
Singapore

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