Ewa Sletten

When and Why Do IPO Firms Manage Earnings

Abstract There is significant disagreement about whether, when, and why IPO firms manage earnings. We precisely identify the timing and motives behind earnings management by IPO firms. The period around an IPO is characterized by two events: the IPO itself and the lockup expiration. Both the raising of capital at the IPO and the exit by pre-IPO shareholders at lockup expiration create incentives for firms to manage earnings. To disentangle the effect of these events, we examine quarterly, rather than annual, abnormal accruals. We find no evidence of income-increasing earnings management before the IPO. However, IPO firms exhibit positive abnormal accruals in the quarter before and the quarter of the lockup expiration. Positive abnormal accruals are concentrated in less scrutinized firms and firms with high selling by pre-IPO shareholders. Moreover, we find that these accruals subsequently reverse and that such reversals contribute to long-run IPO underperformance.

Does Litigation Encourage or Deter Real Earnings Management

In this paper, we rely on an exogenous shock to examine the impact of litigation risk on real earnings management (REM). We conduct differences-in-differences tests centered on an unanticipated court ruling that reduced litigation risk for firms headquartered in the Ninth Circuit. REM increases significantly following the ruling for Ninth-Circuit firms relative to other firms, consistent with litigation risk deterring REM. Additional analyses reveal that REM rises more following the ruling when firms issue more optimistic disclosures. The evidence is consistent with litigation deterring REM by constraining managers’ ability to issue optimistic and misleading disclosures that can conceal the myopic and opportunistic motives underlying REM. We further document that an increase in REM in response to a decline in litigation risk is more pronounced when managers have higher incentives to manipulate earnings and governance mechanisms are weaker.

In Alignment or Conflict? The Role of Shareholder Heterogeneity in the Relation Between Shareholders and Debtholders in Near-Insolvent Firms

The 1991 Delaware court ruling involving Credit Lyonnais expanded the fiduciary duties of managers towards debtholders when a firm is close to insolvency. The ruling arguably increased shareholders’ and managers’ aversion to near-insolvency situations; we examine the possibility that this led to a re-orientation of focus at Delaware firms towards long-term competitiveness rather than short-term goals. Using a differences-in-differences approach that exploits the exogenous shock, we find that the 1991 ruling induced managers of Delaware firms to place a greater emphasis on investments that foster long-term innovation, and a reduced focus on achieving myopic earnings goals. Further, we find a shift away from transient to dedicated institutional ownership after the court ruling. In other words, the shareholder base adjusts to the re-orientation of Delaware firms towards the longer term.

Increased Creditor Rights, Institutional Investors and Corporate Myopia

The 1991 Delaware court ruling involving Credit Lyonnais expanded the fiduciary duties of managers towards debtholders when a firm is close to insolvency. The ruling arguably increased shareholders’ and managers’ aversion to near-insolvency situations; we examine the possibility that this led to a re-orientation of focus at Delaware firms towards long-term competitiveness rather than short-term goals. Using a differences-in-differences approach that exploits the exogenous shock, we find that the 1991 ruling induced managers of Delaware firms to place a greater emphasis on investments that foster long-term innovation, and a reduced focus on achieving myopic earnings goals. Further, we find a shift away from transient to dedicated institutional ownership after the court ruling. In other words, the shareholder base adjusts to the re-orientation of Delaware firms towards the longer term.

Agency Environment, Innovation and Managers’ Long-Term versus Short-Term Focus

The 1991 Delaware court ruling involving Credit Lyonnais expanded the fiduciary duties of managers towards debtholders when a firm is close to insolvency. The ruling arguably increased shareholders’ and managers’ aversion to near-insolvency situations; we examine the possibility that this led to a re-orientation of focus at Delaware firms towards long-term competitiveness rather than short-term goals. Using a differences-in-differences approach that exploits the exogenous shock, we find that the 1991 ruling induced managers of Delaware firms to place a greater emphasis on investments that foster long-term innovation, and a reduced focus on achieving myopic earnings goals. Further, we find a shift away from transient to dedicated institutional ownership after the court ruling. In other words, the shareholder base adjusts to the re-orientation of Delaware firms towards the longer term.