1. Earnings Management and the Long-Run Market Performance of Initial Public Offerings
Hathaiwan Vongsuwan – Hengmin Zhang
Jonnell Tyler – Jose Navarrete – Kamoldis Theamkachit
Now we will talk about the article “Earnings Management and the Long-Run Market Performance of Initial Public Offerings.”

2. Introduction
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
IPO’s underperform after the issue
Earnings Management in Initial Public Offerings
Sample Selection Data
Empirical Results
Post-Issuing Activity
But first let me give you a basic definition of what an Initial Public Offering is, an IPO is a public offering where shares of stock in a company are sold to the general public on a securities exchange for the first time
Through this process, a private company transforms into a public company
And companies usually do this in order to raise capital for expansion, monetize on investments for early private investors, and/or become publicly traded enterprises
Oddly enough, studies show that IPOs underperform after the issue
Now the topics we will be going over are:
Earnings Management in Initial Public Offerings
The Sample Selection Data gathered through this process
The Empirical Results
And, Post-Issuing Activity that occurs

3. Earnings Management in Initial Public Offerings
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
Now, let’s talk about “Earnings Management in Initial Public Offerings.”
The IPO process gives entrepreneurs the opportunity to manage earnings.
After filing an IPO, these entrepreneurs enter a lock up period, usually around 180 days, in which they are not able to sell their personal holdings.
This filing comes at a price because the company is pressured to meet their expected earnings in order to avoid a lawsuit.
Also, in order to avoid any wrongful manipulation of earnings, the company who is filing for an IPO undergoes GAAP verification of its accounting reports.
Overall, the ultimate bottom line for valuation is the company’s cash flows

4. Earnings Management in Initial Public Offerings (Cont.)
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
Decelerating Depreciation
Decreasing deferred taxes
Realizing unusual gains
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
Now, let’s talk about how earnings are measured:
Reported earnings are measured by Cash Flows and Accruals
Total Accruals are composed of current and long-term accruals. Entrepreneurs have more discretion over short-term than long-term accruals
Current accruals are composed of short-term assets and liabilities which support day-to-day operations
Now, managers have the power of manipulating these accruals 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

5. Stock Prices and Earnings Management
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
So what exactly cause a company’s stock price to underperform post-IPO?
Earnings Management over valuates an IPO
If the market was fully efficient, negative returns would not be observed
The stock price of an IPO is not discounted enough to factor in earnings management
Overall, the main cause of Post-IPO stock return underperformance is associated with manager’s manipulation of accruals

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

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

18. return underperformance
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 frequently
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 firm’s cost of equity capital
Accounting standard setters: results may be useful for evaluating the amount of discretion you give corporate managers

20. The end