Do more reputable financial institutions reduce earnings management by IPO issuers?
Journal of Corporate Finance, Forthcoming, March 2011
Gemma Lee, Ph.D. Department of Finance
Ronald W. Masulis
This study investigates whether financial intermediaries (FIs) participating in the IPO process play a significant role in restraining earnings management (EM). Specifically, we examine whether EM around IPOs is negatively related to investment banks (IBs) and venture capital (VC) investor reputations. In general, we do not find evidence that VCs as a group significantly restrain EM by IPO issuers. However, we uncover strong evidence that more reputable VCs and IBs are associated with significantly less EM, which is consistent with them implicitly certifying the quality of issuer financial reports. Moreover, a stronger reduction in EM is found when more reputable IBs are matched with more reputable VCs, which indicates that VC and IB reputation are complements rather than substitutes. These conclusions are invariant to adjustments for potential endogeneity of underwriter reputation and VC-backing or reputation.