A Study On The Effect Of Venture Capital On Earnings Management Of GEM IPOs In China

Earnings management around IPOs is an important issue because it can lead investors to pay an unrealistic price for their shares. Since venture capitalists(VCs) not only inject cash into IPO companies, but also provide a series of value-added services and corporate governance assistance, VCs have a theoretically monitoring role. Through empirical Study, this paper investigates the role of VCs in monitoring financial reportings, in other words, whether VCs can hamper earnings management around IPOs.This paper inspects three phases around the IPO:the year before IPO, the IPO year, the year after IPO. Focusing on GEM and taking into account the special macro interference during the financial crisis, this paper removes2009listed companies and ultimately selects319companies listed during2010-2012as samples. Using modified Cross Sectional Jones Model, this paper does an annually regression to calculate sample companies’discretionary accrual(DA) as a measure of earnings management. Through regression analysis, this paper sets the presence of VC as virtual variables, and controls for factors that could influence the estimated value of earnings management such as size, leverage, sales growth and cash flows. Through this procedure, we are able to investigate, compared with non-venture-backed company, whether there is a lower level of earnings management for venture-backed companies.The study finds:Successful IPO has a great temptation on VCs. There shows VCs’moral hazard the year before the IPO and VCs can not hamper earnings management and may sightly foster it. However, VCs can absolutely expect the IPO companies’good market performance and high return rate, given the detailed assessment of project selection, so the results during the periods after IPO support the supervision hypothesis. After IPO, VCs’moral hazard motivation reduces and begin to play their hampering role on earnings management. But this monitoring and hampering role is time-limited. The year after IPO, as parts of VCs may exit from the invested companies, their monitoring enthusiasm is not high and the monitoring role is not significant.The results indicate that VCs, to some extent, value honest and high-quality financial reportings which could bring them reputation and return on investment. VCs themselves have the conscious to affect the quality of financial reportings, but they do not have strong motivation and aspiration to monitor them. In case of interest confliction, VCs can not significantly constrain earnings management, and may even foster earnings management. Therefore, now the regulatory agencies need to rationalize the mechanism and stimulate VCs’ enthusiasm of providing value-added services system institutionally. Incentive mechanisms that can make VCs which encourage honest reporting recognized by the market and give punishment to VCs fostering earnings management should be established to give VCs proper guidances. Thereby VCs could play their professional capacity and promote the healthy development of China’s capital market.By studying the relationship between venture capital and IPO earnings management, this paper expands the study of earnings management inhibition and verifies VCs’ monitoring role on financial reportings which provides the venture capital study a new beneficial perspective—financial reporting oversight. Meanwhile, this study is significant in promoting the healthy development of China’s capital market and venture capital.