Direct Equity Investment By Security Firms,Pre-IPO Earnings Management And Security Underpricing

Direct equity investment by security firms refers to the investment in the non-public companies made by qualified security firms. Studies on the mature capital markets show that, the implement of this business not only improve the revenue structure of security firms, but bringing benefits to the development of the market and strengthening the relationship between the real economy and the capital market. However, direct equity investment by security firms is highly controversial since the date of arising due to the dual role. Being the underwriter and investor at the same time brings the doubt that the security firms would take advantage of the information superiority to harm the interest of other investors. The development of this business has been accompanied by the above concerns. Since the restart of the business in2007, criticism of transfer of benefits never stopped.This article tries to test the relationship between the presence of direct equity investment by security firms and the earnings quality, how the market reacts to the presence as well. Results show that enterprises with the direct equity investment by security firms while the investor doesn’t take the underwriter role have the worst earnings quality. The difference in earnings quality between the enterprises with dual-role underwriters and enterprises with no such investment is not significant. The dual-role underwriters have chosen a conservative way of investment, picking the average enterprises to invest in. The market correctly recognizes the worst earnings quality of the enterprises with the direct equity investment by security firms while the investor doesn’t take the underwriter role. Meanwhile it is over-optimistic about the enterprises with dual-role underwriters. Although there is presence of assault investment and low-price shares, the results support the restrictive role of regulation. By increasing the degree of marketization of the capital market, improving the regulatory mechanism of the business, it should be able to achieve the original intension of serving the economy development, narrowing the gap between the real economy and the capital market, and further enhancing the overall efficiency of the market.