Earnings management in Malaysian IPOs: The East Asian crisis, ownership control, and post-IPO performance

Abstract

We find evidence of income-increasing earnings management in Malaysian IPOs, which occurs primarily for IPOs during a period of severe economic stress (the East Asian crisis). Within the high ownership concentration Malaysian market, post-IPO control concerns also appear to constrain IPO earnings management: owners seem willing to accept reduced IPO proceeds and signaling opportunities to increase the likelihood of retaining control of the company post-IPO. The requirement to provide a profit guarantee does not seem to greatly affect earnings management. IPO companies engaging in aggressive income-increasing earnings management have significantly worse market-based performance than their more conservative counterparts, but again only for IPOs issued during the economic crisis period. Overall, the results suggest that personal liquidity concerns are an important factor in IPO decisions during the economic crisis. Professor of Accounting and Finance at the University of Stirling. We appreciate the very helpful, constructive comments from Rashad Abdel-Khalik (the editor) and the two anonymous referees who have contributed significantly in helping improve the structure of the paper and the arguments therein. We have also benefited from the comments of Chris Veld, participants at the EAA Annual Conference at University College Dublin and the BAA Annual Conference at Royal Holloway, University of London. The financial support of the Malaysian government (JPA) and the Universiti Utara Malaysia is gratefully acknowledged (for Nurwati A. Ahmad-Zaluki). We thank the Public Information Centre, Kuala Lumpur Stock Exchange (Bursa Malaysia) for the usage of the library and Brahim Saadouni from the University of Manchester for the provision of his PACAP database and his collection of Malaysian prospectuses. The usual disclaimer applies. JEL classification: G32 Earnings management in Malaysian IPOs: the EastAsian crisis, ownership control and post-IPO performance AbstractWe find evidence of income-increasing earnings management in Malaysian IPOs, which occurs primarily for IPOs during a period of severe economic stress (the East Asian crisis). Within the high ownership concentration Malaysian market, post-IPO control concerns also appear to constrain IPO earnings management: owners seem willing to accept reduced IPO proceeds and signaling opportunities to increase the likelihood of retaining control of the company post-IPO. The requirement to provide a profit guarantee does not seem to greatly affect earnings management. IPO companies engaging in aggressive incomeincreasing earnings management have significantly worse market-based performance than their more conservative counterparts, but again only for IPOs issued during the economic crisis period. Overall, the results suggest that personal liquidity concerns are an important factor in IPO decisions during the economic crisis. JEL classification: G32

Corporate Governance and Firm‐specific Stock Price Crashes

“…Interestingly, unlike prior research, we do not find that the opacity of the financial reports increases stock crashes (Hutton et al, 2009). Further analysis reveals that this lack of a positive relationship is driven by the financial crisis, an economic downturn period in which managers had limited opportunities and fewer incentives to stockpile negative information through earning management practices (Ahmad-Zaluki et al, 2011;Bertomeu and Magee, 2011;Chia et al, 2007;Filip and Raffournier, 2014;Jenkins et al, 2009) a precursor situation to stock price crashes.…”

“…surrounding an economic downturn period the market is more inclined to tolerate poor performance, (Ahmad-Zaluki et al, 2011) and as a consequence, managers have fewer incentives to engage in earnings management to mask any bad news. Moreover during a recession period, firms may also be subject to increased monitoring from auditors, creditors and other stakeholders which should also result in managers having less discretion to alter their earnings (Bertomeu and Magee, 2011;Chia et al, 2007;Filip and Raffournier, 2014).…”

IPO Underpricing After the 2008 Financial Crisis: A Study of the Chinese Stock Markets

“…IPO underpricing refers to the difference between the price at which the shares are sold to investors during the offering procedure and the price at which the shares are traded in the secondary market. IPO underpricing has been empirically investigated in numerous countries and the results reveal that this phenomenon occurs all over the world [19][20][21][22][23]. A firm's information and the IPO costs significantly influence corporate financial performance and sustainable development [7].…”

“…IPO companies engaging in aggressive income-increasing earnings management are proved to have a significantly worse market-based performance. For these companies, personal liquidity concerns are an important factor in IPO decisions during the economic crisis [20]. Blocker and Sandner (2009) found that the financial crisis is related to a 20% decrease in the average amount of funds raised per funding round [8].…”

“…Firstly, to the best of our knowledge and the literature in hand, this study is one of the few to study the nexus between the financial crisis and IPO underpricing from an empirical perspective [8,19,20]. Previous literature has studied the influences of financial crisis on cash holding and market-based performance.…”