A Study On Nature And Constraint Mechanism Of Earnings Management Surrounding IPO

The Initial public offering market is a special market, due to “contracting frictions”and “blocked communication” between issuers and investors, earnings managementsurrounding IPO is very common. Throughout the related studies of earnings managementsurrounding IPO, there are two important issues. One is the nature of earningsmanagement surrounding IPO, the other is the constraint mechanism of earningsmanagement surrounding IPO. For the first one, there are two different views. Someresearchers think the manager takes advantage of earnings management to obtain someprivate gain; others argue earnings management can be used to deliver a more precisemeasure of firm performance. Is earnings management opportunistic or signaling? Whichis still a theoretical and empirical question needed to be answered. Nevertheless, no matterwhich kind of view, earnings management may lead to interest redistribution effect andtrigger the wealth retribution between the related persons. Excessive earnings managementeasily evolve into accounting fraud, insider trading and other illegal behavior, which canharm efficiency of capital allocation and even lead to stock market failure. Studying onnature and constraint mechanism of earnings management surrounding IPO can promotethe healthy and sustainable development of IPO market.Based on the literature review, this paper firstly uses statistical simulation method toevaluate the specification and power of different discretionary accruals in the Chinesecontext, to looking for the suitable measure model. Then we theoretically and empiricallyanalyze the nature of earnings management surround IPO. Finally, based on issuingsupervision system changes, we study the dynamic change on the level and means ofearnings management by Chinese IPO firms. This paper has three main conclusions:In the third chapter of this article, this paper evaluates alternative discretionaryaccruals models for detecting earnings management. This comparison uses test statistics toevaluate the specification and power of different discretionary accruals in the Chinesecontext. Specifically, we assess the Jones standard model, the modified Jones model, theJones model with intangible assets, the Jones model with ROA, The forward-lookingmodified Jones model, the Jones model with cash flow, and the non-linear Jones model.We find that:(1) the Jones standard model, the Modified Jones model and the Jones modelwith intangible assets exhibit well specified and the better power in detecting earningsmanagement, especially the modified Jones model, which is more powerful than its standard version at detecting revenue-based manipulation.(2)The Jones model with cashflow and the non-linear Jones model exhibit the most power in detecting earningmanagement, but appear worse specified when applied to a random sample of firm-years.(3)The forward-looking modified Jones model is complicated in computation and itdoesn’t improve the power in detecting earnings management than the original modifiedversion.(4)The Jones mode with ROA performs is worst at detecting expense-basedearnings management. Finally we think it is advisable to put the cross-sectional modifiedJones model in priority when we use the discretionary accruals models in our research ofthe earnings management in the Chinese stock market.In the forth chapter of the article, we distinguish between IPO firms according to thereputation ranking of underwriters. We find that IPO firms associated with moreprestigious underwriters have significantly less aggressive earnings management, and thatthe negative relationship between earnings management and the post-IPO performance ofa firm’s stocks is discernible only for firms associated with less prestigious underwriters,with no significant results being found for firms associated with more prestigiousunderwriters. Our findings suggest that the firms’ type determines the nature of earningsmanagement.In the fifth chapter of the article, this paper studies the dynamic change on the leveland means of earnings management by Chinese IPO firms. Based on Chinese stockissuance system evolution, we adopt Jones model and real earnings management model asour measure of earning management, while providing controls for the changes indiscretionary accruals attributable to changes in performance. We found the level ofearnings management declines with the transformation from authorized system toapproval system, and from channel system to sponsor system, but we can’t find the accrualmanagement and real management action can replace each other. On the whole, our studyproves stock issuance system reform can restrain the opportunistic earnings managementactions and improve the earnings quality of Chinese IPO firms.Our paper contributes to the extant literature on the nature of IPO firm’s earningsmanage by verifying that the firms’ type determines the nature of earnings management,These findings could provide one possible explanation to the dispute betweenopportunistic earnings management view and signal view. Meanwhile what we foundshow the Chinese underwriter reputation mechanism is effective to a certain extent. Ourstudy is also closely related to the literature on the constraint mechanism of earningsmanagement surrounding IPO by proving stock issuance system reform can restrain the opportunistic earnings management actions surrounding IPO, What we finding providessupport for the market-oriented stock supervision system reform.