Earnings Management and Performance of IPO Firms: Evidence from India

Abstract

Disclosure through corporate annual reports is intended to enhance transparency and reduce information asymmetry during public issues. Ritter (1991) revealed that there is something fishy in the financial reports of the companies coming out with public issues. Earnings management has been recognised as a foremost contributor to such misleading financial reports. The short term overperformance of initial public offerings (IPO) of companies increases the expectations of potential investors and leads to a subsequent decline of performance in long run leaving the investors in distraught. The observed phenomenon is omnipresent and thus affects the investors across the globe. The present article empirically investigates the presence of earnings management in IPOs in India. The study is based on Modified Jones Model, the best known model to measure accruals earnings management. Preliminary results exhibit that earnings management in Indian IPOs is much higher than in developed countries. The study further discovers that the earnings performance of IPO companies is abnormally higher in IPO year as compared with post-offer period. Both the results taken together reinforce that post-issue earnings performance is a derivation of issue year earnings management in India.

Earnings Management and IPO Anomalies—Evidence from Indian Stock Market

“…Furthermore, it is also evidenced that firms that have used abnormal accruals more conservatively while reporting earnings have better returns in the third year after the offering compared to the firms that used abnormal accruals aggressively. This observation was similar to studies conducted in China (Aharony et al, 2010;Shen et al, 2014) and India (Mangala & Dhanda, 2019;Purayil & Jijo Lukose, 2019).…”

“…The other way to look at this phenomenon, particularly in India, is that firms that engage in aggressive earnings management, prior to IPO, would have to go for a "course correction" and that would eventually reduce the earnings and the price, post-IPO. Similar results were also evidenced in related studies on India (Mangala & Dhanda, 2019;Purayil & Jijo Lukose, 2019;Shette et al, 2016). Shette et al in their study showed that new issue firms performed poorly in the long run.…”

“…Similar results have emerged from the United States (DuCharme et al, 2001;Teoh et al, 1998a), The Netherlands (Roosenboom, et al, 2003), and China (Aharony et al, 2010;Gao et al, 2015;Shen et al, 2014). Some related studies in India also found a negative relationship between pre-IPO earnings management and long-term performance of the firm's stock (Mangala & Dhanda, 2019;Purayil & Jijo Lukose, 2019). However, studies like Ball and Shivakumar (2008) and Fan (2007) found a contradictory result.…”

“…This study also observed declining returns in the post-IPO period for firms that aggressively managed earnings in the pre-IPO period. This study is one of the few studies (Gao et al, 2015;Mangala & Dhanda, 2019;Nagata, 2013;Purayil & Jijo Lukose, 2019) that examined the association between earnings management and underpricing and subsequent returns among IPO firms in the context of an emerging market. The rest of this article is organized as follows.…”

Earnings Management and New Listings: Evidence from Vietnam

“…However, the earnings management around this phenomenon provides conflicting results in the literature. One view provides strong empirical evidence that some firms manipulate accruals aggressively or earnings upward around new issuance (Ahmad-Zaluki, 2008;Chiraz, 2013;DuCharme et al, 2004;Gresse & Gajewski, 2006;Li et al, 2005;Mangala & Dhanda, 2019;Nuryaman, 2013;Roosenboom et al, 2003;Teoh et al, 1998aTeoh et al, , 1998b. Different views are provided by researchers such as Beaver et al (2000), Qintao (2007), Ball and Shivakumar (2008), Armstrong et al (2008), Premti (2013), and Chou et al (2009) which show no evidence of earnings signals around new issuance.…”