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Hathaiwan Vongsuwan – Hengmin Zhang Jonnell Tyler – Jose Navarrete – Kamoldis Theamkachit Earnings Management and the Long-Run Market Performance of Initial.

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Presentation on theme: "Hathaiwan Vongsuwan – Hengmin Zhang Jonnell Tyler – Jose Navarrete – Kamoldis Theamkachit Earnings Management and the Long-Run Market Performance of Initial."— Presentation transcript:

1 Hathaiwan Vongsuwan – Hengmin Zhang Jonnell Tyler – Jose Navarrete – Kamoldis Theamkachit Earnings Management and the Long-Run Market Performance of Initial Public Offerings

2 Initial Public Offering (IPO) - Public offering where shares of stock in a company are sold to the general public on a securities exchange for the first time A private company transforms into a public company Used by companies to raise expansion capital, monetize the investments of early private investors, and to become publicly traded enterprises IPOs underperform after the issue I. Earnings Management in Initial Public Offerings II. Sample Selection Data III. Empirical Results IV. Post-Issuing Activity Introduction

3 The IPO Process Opportunities to manage earnings Lock up period of 180 days Pressure to meet earnings In offering prospectus, accounting reports undergo verification of GAAP compliance Cash flows are the ultimate bottom line for valuation I.Earnings Management in Initial Public Offerings

4 Measures of Earnings Reported Earnings Cash Flows and Accruals Total Accruals Current and Long-Term Current Short-term assets and Liabilities Manipulated by: Advancing recognition of revenues with credit sales Delaying recognition of expenses for bad debt Deferring recognition of expenses when cash is advanced to suppliers Long-Term Long-Term Net Assets Manipulated by: Decelerating Depreciation Decreasing deferred taxes Realizing unusual gains Earnings Management in Initial Public Offerings (Cont.) Measures of Earnings Appropriate and Necessary Accruals Fixed-asset intensive firms High Depreciation Rapidly Growing Firms Revenues exceed cash sales Cross Sectional Regression Current accruals are regressed Performed each fiscal year

5 Post-IPO stock return underperformance Earnings management create an over valuation of an IPO Negative returns would not be observed if market was fully efficient No discount for earnings management Management manipulation of accruals Stock Prices and Earnings Management

6 II. Sample Selection & Data Initial Samples of domestic U.S (IPOs) consist of: 1980 – 1984 :1,974 IPOs 1985 – 1992 :3,197 IPOs For inclusion in Final Sample, IPOs must have: a. Available COMPUSTAT financial data b. CRSP stock return data c. Offer price exceeding $1.00 d. Market capitalization of at least 20 million Final Sample size: 1,649 IPOs

7 II. Sample Selection & Data cont… Fiscal Year -1: ends before the date of the IPO Fiscal Year 0: the IPO occurs (includes both pre and post IPO information, financial statements taken from year 0 as well

8 II. Sample Selection & Data cont… Sample Characteristics: SIC Distribution

9 II. Sample Selection & Data cont… Sample Characteristics : Time Distribution

10 II. Sample Selection & Data Sample Characteristics: Post-IPO characteristics

11 III. Empirical Results Key objective: managed accruals have an influence on the long-run abnormal stock return performance of IPO firms All tests indicate that discretionary current accruals reliably predict post- IPO returns

12 III. Empirical Results Distribution of Stock Returns by DCA Quartile Event-Time Cross-Sectional Regressions Time-Series Regressions Using Book-to-Market and Market Capitalization Adjusted Returns Fama-MacBeth Panel Regression

13 A. Distribution of Stock Returns by DCA Quartile DCA Discretionary Current Accruals Inferences on the magnitude of IPO long-run underperformance are sensitive to the abnormal return computation More conservative firms outperform more aggressive firms by a margin that is economically significant

14 B. Event-Time Cross-Sectional Regressions Add four accrual variables to the regression to examine the incremental influence of the accrual variables on post-issue stock return underperformance Only the DCA variable is consistently robust across a variety of alternative regression specifications

15 C. Time-Series Regressions Using Book-to-Market and Market Capitalization Adjusted Returns Aggressive IPOs have statistically significantly poorer post-issue performance than conservative IPOs

16 D. Fama-MacBeth Panel Regression It is incrementally important during an initial public offering for the earnings management variable to explain post-IPO long-run performance

17 Aggressive Earnings Management Leads to Poorer after-market performance Post-Issuing Activity

18 Conclusion Discretionary current accruals (DCA) (proxy for earnings management) are high around the IPO Issuers with higher (DCA) have poorer stock returns Aggressive firms, on average, 15-30% worst performance than conservative firms Conservative firms, seasoned equity offering 20% more frequentl y Long-run post-IPO return underperformance IPO firms earnings management

19 Conclusion Implications Investors: should look at pre-offering accounting accruals to discriminate amongst issuers Entrepreneurs: legitimate accounting choices can lower firms cost of equity capital Accounting standard setters: results may be useful for evaluating the amount of discretion you give corporate managers

20 The end


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