Do Venture Capitalists Influence the Decision to Manage Earnings in Initial Public Offerings?

Abstract

Prior studies suggest that venture capitalists (VCs) play a monitoring role. We predict and find that IPO-year abnormal accruals are lower in the presence of VCs for a sample of 2,630 IPO firms during 1983–2001. Our findings are robust to controls for the endogenous choice of VC financing. We consistently find that the VC effect holds even when controlling for IPO lock-up provisions, VC partial cashing out subsequent to the IPO, and alternative proxies for earnings management. In addition, our findings do not support the claims of critics that VCs inflated earnings during the Internet IPO bubble. Finally, we provide some evidence that the lower earnings management associated with VC monitoring partially explains the superior post-IPO returns of VC-backed firms.

The effects of venture capital syndicate diversity on earnings management and performance of IPOs in the US and UK: An institutional perspective

“…Accordingly, we first calculated the current accruals (CA) as the difference between the change in noncash current assets and the change in operating current liabilities (Morsfield and Tan, 2006): …”

“…This type of behavior is a typical manifestation of the principal-agent problem between IPO insiders and incoming public market investors. Given the importance of an experience-based reputation in the VC industry, VC firms may play a monitoring role which constrains opportunistic earnings management at IPO (Morsfield and Tan, 2006).…”

“…VCs usually screen their portfolio companies and prepare them to go public. As sophisticated investors, they employ an extensive set of covenants to protect their investments (Barry et al, 1990), and their active involvement in portfolio companies is likely to deter earnings management and strengthen the corporate governance of their firms (Morsfield and Tan, 2006;Brau and Johnson, 2009). However, venture capital firms are subject to different pressures from their limited partners (Bruton et al, 2010) and, as syndicate members, they have different objectives which can result in principal-principal conflicts of interests among members of a VC syndicate, and thus adversely affect the quality of the monitoring of their portfolio companies (Hochberg et al, 2007).…”

Debt Issues and Earnings Management

“…For Morsfield and Tan (2006), the external auditor's reputation could be damaged if they are not able to identify accounting distortions. Because of this, the expected result for the Auditor i variable is negative.…”

Monitoring or Moral Hazard? Evidence from Real Activities Manipulation by Venture-Backed Companies*

“…First, examining only one earnings management technique at a time cannot explain the overall effect of earnings management activities (Fields, Lys, and Vincent 2001). Though prior researchers have investigated discretionary accruals manipulation (Morsfield and Tan 2006), it is still necessary to examine real activities manipulation. In a survey study, Graham, Harvey, and Rajgopal (2005) find that managers are more willing to engage in real activities manipulation (RM) than in discretionary accruals manipulation (AM); 80% would decrease discretionary spending; 55% would delay a project;…”