Earnings management in the private equity divestment process on Warsaw Stock Exchange

  • Tomasz Sosnowski University of Lodz
Keywords: initial public offering, private equity, earnings management

Abstract

Research background: Prior studies suggest that companies which go public manage earnings in order to inflate the issue price. However, for private equity funds the use of such activity can be costly in terms of the reputation capital as they are repetitive stock market players. The results of previous research on the effect of private equity fund on the quality of pre-IPO reported earnings are mixed and inconclusive.

Purpose of the article: The main aim of the study is to empirically investigate the use of pre-IPO earnings management by private equity funds in the process of divestment conducted on a stock exchange.

Methods: I provide comparisons between PE-backed companies and firms with a similar initial market value and growth potential, using the method of single-linkage clustering to build the study sample. In order to assess the scale of pre-IPO earnings management, I apply the discretionary accruals model of Larcker and Richardson [2004].

Findings & Value added: Using a sample of companies conducting IPO on WSE between 2005 and 2015 I do not find evidence that the presence of private equity fund among the shareholders of the company in the period preceding first listing of shares on a stock market constrains the use of earnings management prior to the IPO. The difference between the discretionary accruals in PE-backed and matched companies, when controlling for the market value and book-to-market ratio, is statistically insignificant. To be specific, companies with private equity funds in their shareholder structure do not exhibit lower scale of earnings management prior to the IPO in comparison to other new stock companies.

Downloads

Download data is not yet available.

References

Arya, A., Glover, J. C., & Sunder, S. (2003). Are unmanaged earnings always better for shareholders? Accounting Horizons, 17(S-1). doi: 10.2308/acch.2003. 17.s-1.111.

Ball, R., & Shivakumar, L. (2008). Earnings quality at initial public offerings. Journal of Accounting and Economics, 45(2-3). doi: 10.1016/j.jacceco. 2007.12.001.

Black, B. S., & Gilson, R. J. (1998). Venture capital and the structure of capital markets: banks versus stock markets. Journal of Financial Economics, 47. doi: 10.1016/S0304-405X(97)00045-7.

Cadman, B., & Sunder, J. (2014). Investor horizon and CEO horizon incentives. Accounting Review, 89(4). doi: 10.2308/accr-50719.

Cerqueira, A., & Pereira, C. (2015). Accounting accruals and information asymmetry in Europe. Prague Economic Papers, 24(6). doi: 10.18267/j.pep.528.

Chahine, S., Arthurs, J. D., Filatotchev, I., & Hoskisson, R. E. (2012). The effects of venture capital syndicate diversity on earnings management and performance of IPOs in the US and UK: an institutional perspective. Journal of Corporate Finance,18(1). doi: 10.1016/j.jcorpfin.2011.11.007.

Cherkasova, V., & Rasadi, D. (2017). Earnings quality and investment efficiency: evidence from Eastern Europe. Review of Economic Perspectives, 17(4). doi: 10.1515/revecp-2017-0023.

Cohen, D. A., & Langberg, N. S. (2009). Venture capital financing and the informativeness of earnings. Asia-Pacific Journal of Accounting & Economics, 16(2). doi: 10.1080/16081625.2009.9720836.

Cumming, D. J., & Macintosh, J. G. (2003). A cross-country comparison of full and partial venture capital exits. Journal of Banking & Finance, 27(3). doi: 10.1016/s0378-4266(02)00389-8.

Darrough, M., & Rangan, S. (2005). Do insiders manipulate earnings when they sell their shares in an initial public offering? Journal of Accounting Research, 43(1). doi: 10.1111/j.1475-679x.2004.00161.x.

Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1995). Detecting earnings management. Accounting review, 70(2).

DuCharme, L. L., Malatesta, P. H., & Sefcik, S. E. (2004). Earnings management, stock issues, and shareholder lawsuits. Journal of Financial Economics, 71(1). doi: 10.1016/s0304-405x(03)00182-x.

Ecker, F., Francis, J., Olsson, P., & Schipper, K. (2013). Estimation sample selection for discretionary accruals models. Journal of Accounting and Economics, 56(2-3). doi: 10.1016/j.jacceco.2013.07.001.

Ertimur, Y., Sletten, E., Sunder, J., & Weber, J. (n.d.). When and why do IPO firms manage earnings? SSRN Electronic Journal. doi:10.2139/ssrn.2704621.

Fama, E. F., & French, K. R. (1996). Multifactor explanations of asset pricing anomalies. Journal of Finance, 51(1). doi:10.2307/2329302.

Gioielli, S. P., Carvalho, A. G., & Sampaio, J. O. (2013). Venture capital and earnings management in IPOs. Brazilian Business Review, 10(4). doi: 10.15728/bbr. 2013.10.4.2.

Grabiński K. (2016). Wpływ kryzysu gospodarczego na aktywne kształtowanie wyniku finansowego w europejskich spółkach giełdowych. Zeszyty Teoretyczne Rachunkowości, 87(143).

Graham J. R., Harvey C. R., & Rajgopal S. (2005), The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1−3).

Healy, P. M., & Wahlen, J. M. (1999). A review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13(4). doi: 10.2308/acch.1999.13.4.365.

Hochberg, Y. V. (2012). Venture capital and corporate governance in the newly public firm. Review of Finance, 16(2). doi: 10.1093/rof/rfr035.

Hu, Z., Cai, W., Han, J., & Sa, R. (2012). An empirical study of the effect of venture capital participation on the accounting information quality of IPO firms. China Journal of Accounting Research, 5(3). doi: 10.1016/j.cjar.2012.08.004.

Huyghebaert, N., & Hulle, C. V. (2006). Structuring the IPO: empirical evidence on the portions of primary and secondary shares. Journal of Corporate Finance, 12(2). doi: 10.1016/j.jcorpfin.2005.01.001.

Jones, J. J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29(2). doi: 10.2307/2491047.

Kaplan, S. N., Martel, F., & Strömberg, P. (2007). How do legal differences and experience affect financial contracts? Journal of Financial Intermediation, 16(3). doi: 10.1016/j.jfi.2007.03.005.

Katz, S. P. (2009). Earnings quality and ownership structure: the role of private equity sponsors. Accounting Review, 84(3).

Krishnan, C. N., Ivanov, V. I., Masulis, R. W., & Singh, A. K. (2011). Venture capital reputation, post-IPO performance, and corporate governance. Journal of Financial and Quantitative Analysis,46(05). doi: 10.1017/s0022109011000251.

Larcker, D. F., & Richardson, S. A. (2004). Fees paid to audit firms, accrual choices, and corporate governance. Journal of Accounting Research, 42(3). doi: 10.1111/j.1475-679x.2004.t01-1-00143.x.

Lindahl, F., & Schadéwitz, H. (2017). Accounting quality in Eastern Europe after communism. Journal of East-West Business, 24(1). doi: 10.1080/10669868. 2017.1403988.

Liu, X. (2013). Venture capitalists and portfolio companies’ real activities manipulation. Review of Quantitative Finance and Accounting, 43(1). doi: 10.1007/ s11156-013-0369-5.

Masulis R. W., & Thomas, R. S. (2009). Does private equity create wealth? The effects of private equity and derivatives on corporate governance. University of Chicago Law Review, 76.

Meluzín, T., Zinecker, M., Balcerzak, A. P., & Pietrzak, M. B. (2018). Why do companies stay private? Determinants for IPO candidates to consider in Poland and the Czech Republic. Eastern European Economics, 56(6). doi: 10.1080/ 00128775.2018.1496795.

Morsfield, S. G., & Tan, C. E. (2006). Do venture capitalists influence the decision to manage earnings in initial public offerings? Accounting Review, 81(5). doi: 10.2308/accr.2006.81.5.1119.

Nahata, R. (2008). Venture capital reputation and investment performance. Journal of Financial Economics, 90(2). doi: 10.1016/j.jfineco.2007.11.008.

Narzo, A. F., Freo, M., & Mattei, M. M. (2018). Estimating accruals models in Europe: industry-based approaches versus a data-driven approach. Economic Research-Ekonomska Istraživanja, 31(1). doi:10.1080/1331677x.2017. 1421991.

Schipper, K. (1989). Commentary on earnings management. Accounting Horizons (December)

Sieradzki, R, & Zasępa, P. (2016), Underpricing of private equity/venture capital backed IPOs. Do they differ from other offers? Argument Oeconomica, 1(36).

Sosnowski, T. (2017). Corporate governance and the time to full exit in the private equity divestment process on Warsaw Stock Exchange. Acta Universitatis Lodziensis. Folia Oeconomica, 2(328). doi:10.18778/0208-6018.328.02.

Subramanyam, K. (1996). The pricing of discretionary accruals. Journal of Accounting and Economics, 22(1-3). doi:10.1016/s0165-4101(96)00434-x.

Teoh, S. H., Welch, I., & Wong, T. (1998). Earnings management and the long-run market performance of initial public offerings. Journal of Finance, 53(6). doi: 10.1111/0022-1082.00079.

Wójtowicz, P. (2015). Earnings management to achieve positive earnings surprises in case of medium size companies listed in Poland. International Journal of Accounting and Economics Studies, 3(2). doi: 10.14419/ijaes.v3i2.5258.

Wongsunwai, W. (2012). The effect of external monitoring on accrual-based and real earnings management: evidence from venture-backed initial public offerings. Contemporary Accounting Research, 30(1). doi:10.1111/j.1911-3846. 2011.01155.x.

Xie, H. (2001). The mispricing of abnormal accruals. Accounting Review, 6(3). doi: 10.2308/accr.2001.76.3.357.

Zarowin, P. (2015). Estimation of discretionary accruals and the detection of earnings management. Oxford Handbooks Online, doi: 10.1093/oxfordhb/ 9780199935406.013.20.

Published
2018-12-31
How to Cite
Sosnowski, T. (2018). Earnings management in the private equity divestment process on Warsaw Stock Exchange. Equilibrium. Quarterly Journal of Economics and Economic Policy, 13(4), 689-705. https://doi.org/10.24136/eq.2018.033
Section
Articles