Advertisement

Review of Accounting Studies

, Volume 22, Issue 4, pp 1541–1581 | Cite as

The sharpest tool in the shed: IPO financial statement management of STEM vs. non-STEM firms

  • Tatiana Fedyk
  • Zvi Singer
  • Mark SolimanEmail author
Article

Abstract

The valuation of STEM (science, technology, engineering, and math) firms has recently gained attention in the literature. Research has shown that, for valuation of STEM firms, accounting items such as sales growth and R&D expenditures matter more than bottom-line earnings. We examine whether, around the time of the IPO, STEM managers apply discretion over the accounting items most weighted by investors for their valuation. We find that investors tend to weigh sales growth and R&D more heavily than earnings in valuing STEM firms and that managers respond by managing those items rather than bottom-line earnings as in prior research. We find that future stock returns of STEM firms are negatively associated with sales management and not with abnormal accruals as for non-STEM firms. Our results illuminate the differential behavior of STEM managers and highlight the importance of a departure from the traditional IPO earnings management paradigm, which assumes that firms mainly manage their earnings.

Keywords

STEM firms Initial public offering Discretion over accounting items IPO valuation Earnings management 

JEL classification

M13 M41 K22 G14 G32 

Notes

Acknowledgements

We are grateful for the insightful suggestions we received from Patricia Dechow (the editor). We would also like to thank two anonymous reviewers, the 2012 annual conference on Financial Economics and Accounting participants, and seminar participants at Arizona State University, Stanford University, University of San Francisco, and University of Washington at Bothell for their comments and suggestions.

References

  1. Aggarwal, R., Bhagat, S., & Rangan, S. (2009). The impact of fundamentals and signaling on IPO valuation. Financial Management, 38(2), 253–284.CrossRefGoogle Scholar
  2. Aggarwal, R., Bhagat, S., & Rangan, S. (2012). Valuation of IPOs. In D. Cumming (Ed.), The Oxford handbook of venture capital (pp. 495–525). Oxford: Oxford University Press.Google Scholar
  3. Aharony, J., Lin, C., & Loeb, M. (1993). Initial public offerings, accounting choices, and earnings management. Contemporary Accounting Research, 10(1), 61–81.CrossRefGoogle Scholar
  4. Ahuja, G., Coff, R., & Lee, P. (2005). Managerial foresight and attempted rent appropriation: Insider trading on knowledge of imminent breakthroughs. Strategic Management Journal, 26, 791–808.CrossRefGoogle Scholar
  5. Andre, P., Magnan, M., & Xu, B. (2007). The stock market valuation of R&D information in biotech firms. Contemporary Accounting Research, 24(4), 1291–1318.CrossRefGoogle Scholar
  6. Armstrong, C., Foster, G., & Taylor, D. (2016). Abnormal accruals in newly public companies: Opportunistic misreporting or economic activity? Management Science, 62(5), 1316–1338.CrossRefGoogle Scholar
  7. Ball, R., & Shivakumar, L. (2008). Earnings quality at initial public offerings. Journal of Accounting and Economics, 45(2–3), 324–349.CrossRefGoogle Scholar
  8. Barclay, M., Gode, D., & Kothari, S. (2005). Matching delivered performance. Journal of Contemporary Accounting & Economics, 1(1), 1–25.Google Scholar
  9. Bartov, E., Mohanram, P., & Seethamraju, C. (2002). Valuation of internet stocks—An IPO perspective. Journal of Accounting Research, 40(2), 321–346.CrossRefGoogle Scholar
  10. Beaver, W. (1968). The information content of annual earnings announcements. Journal of Accounting Research, 6, 67–92.CrossRefGoogle Scholar
  11. Berger, P. (1993). Explicit and implicit tax effects of the R&D tax credit. Journal of Accounting Research, 31(2), 131–171.CrossRefGoogle Scholar
  12. Bernard, V., & Skinner, D. (1996). What motivates managers' choice of discretionary accruals? Journal of Accounting and Economics, 22(1–3), 313–325.Google Scholar
  13. Bowen, R., Davis, A., & Rajgopal, S. (2002). Determinants of revenue-reporting practices for internet firms. Contemporary Accounting Research, 19(4), 523–562.CrossRefGoogle Scholar
  14. Callen, J., Robb, S., & Segal, D. (2008). Revenue manipulations and restatements by loss firms. Auditing: A Journal of Practice & Theory, 27(2), 1–29.CrossRefGoogle Scholar
  15. Carter, R., & Manaster, S. (1990). Initial public offerings and underwriter reputation. Journal of Finance, 45, 1045–1067.CrossRefGoogle Scholar
  16. Cecchini, M., Jackson, S., & Liu, X. (2012). Do initial public offering firms manage accruals? Evidence from individual accounts. Review of Accounting Studies, 17(1), 22–40.CrossRefGoogle Scholar
  17. 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), 1–33.CrossRefGoogle Scholar
  18. Darrough, M., & Ye, J. (2007). Valuation of loss firms in knowledge-based economy. Review of Accounting Studies, 12, 61–93.CrossRefGoogle Scholar
  19. Davis, A. (2002). The value relevance of revenue for internet firms: Does reporting grossed-up and barter revenue make a difference? Journal of Accounting Research, 40(2), 445–477.CrossRefGoogle Scholar
  20. Dechow, P. (1994). Accounting earnings and cash flows as measures of firm performance: The role of accounting accruals. Journal of Accounting Research, 18(1), 3–42.Google Scholar
  21. Dechow, P., Sloan, R., & Sweeney, A. (1995). Detecting earnings management. The Accounting Review, 70, 193–225.Google Scholar
  22. Dechow, P., Ge, W., & Schrand, C. (2010). Understanding earnings quality: A review of the proxies, their determinants, and their consequences. Journal of Accounting and Economics, 50, 344–401.CrossRefGoogle Scholar
  23. Dechow, P., Lawrence, A., & Ryans, J. (2016). SEC comment letters and insider sales. The Accounting Review, 91, 401–439.CrossRefGoogle Scholar
  24. DeFond, M., & Jiambalvo, J. (1994). Debt covenant violation and manipulation of accruals. Journal of Accounting and Economics, 17, 145–176.CrossRefGoogle Scholar
  25. Demers, E., & Joos, P. (2007). IPO failure risk. Journal of Accounting Research, 45(2), 333–371.CrossRefGoogle Scholar
  26. Demers, E., & Lev, B. (2001). A rude awakening: Internet shakeout in 2000. Review of Accounting Studies, 6(2–3), 331–359.CrossRefGoogle Scholar
  27. Dichev, I., Graham, J., Harvey, C., & Rajgopal, S. (2013). Earnings quality: Evidence from the field. Journal of Accounting and Economics, 56, 1–33.CrossRefGoogle Scholar
  28. Downes, D., & Heinkel, R. (1982). Signaling and the valuation of unseasoned new issues. Journal of Finance, 37(1), 1–10.CrossRefGoogle Scholar
  29. DuCharme, L., Malatesta, P., & Sefcik, S. (2001). Earnings management: IPO valuation and subsequent performance. Journal of Accounting, Auditing and Finance, 16(4), 369–396.CrossRefGoogle Scholar
  30. Ertimur, Y., Livnat, J., & Martikainen, M. (2003). Differential market reactions to revenue and expense surprises. Review of Accounting Studies, 8, 185–211.CrossRefGoogle Scholar
  31. Ertimur, Y., Sletten, E., Sunder, J., & Weber, J. (2016). When and why do IPO firms manage earnings? Working paper. University of Colorado at Boulder.Google Scholar
  32. Fama, E., & French, K. (2004). New lists: Fundamentals and survival rates. Journal of Financial Economics, 73(2), 229–269.CrossRefGoogle Scholar
  33. Fan, Q. (2007). Earnings management and ownership retention for initial public offering firms: Theory and evidence. The Accounting Review, 82(1), 27–64.CrossRefGoogle Scholar
  34. Francis, J., & Schipper, K. (1999). Have financial statements lost their relevance? Journal of Accounting Research, 37(2), 319–352.CrossRefGoogle Scholar
  35. Friedlan, J. (1994). Accounting choices of issuers of initial public offerings. Contemporary Accounting Research, 11(1), 1–31.CrossRefGoogle Scholar
  36. Graham, B., & Dodd, D. (1934). Security analysis. New York: McGraw-Hill.Google Scholar
  37. Graham, J., Harvey, C., & Rajgopal, S. (2005). The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40, 3–73.CrossRefGoogle Scholar
  38. Griliches, Z. (1984). R&D, patents and productivity. Chicago: University of Chicago Press.CrossRefGoogle Scholar
  39. Gunny, K. (2010). The relation between earnings management using real activities manipulation and future performance: Evidence from meeting earnings benchmarks. Contemporary Accounting Research, 27(3), 855–888.CrossRefGoogle Scholar
  40. Guo, R., Lev, B., & Zhou, N. (2005). The valuation of biotech IPOs. Journal of Accounting, Auditing and Finance, 20(4), 423–459.CrossRefGoogle Scholar
  41. Guo, R., Lev, B., & Shi, C. (2006). Explaining the short- and long-term IPO anomalies in the US by R&D. Journal of Business, Finance, and Accounting, 33(3), 550–579.CrossRefGoogle Scholar
  42. Hall, B., Jaffe, A., & Trajtenberg, M. (2005). Market value and patent citations. RAND Journal of Economics, 36, 16–38.Google Scholar
  43. Hand, J. (2001). The role of economic fundamentals, web traffic, and supply and demand on the pricing of U.S. internet stocks. European Finance Review, 5, 295–317.CrossRefGoogle Scholar
  44. Hand, J. R. M. (2003) Profits, losses and the non-linear pricing of internet stocks. In J. R. M. Hand & B. Lev (Eds.), Intangible assets: values, measures and risks. New York: Oxford University Press.Google Scholar
  45. Harmon, S. (2000). The metrics for evaluating internet companies. The internet stock report, February 23rd. http://www.Internetstockreport.Com/column/article/0,1785,1661 71961,00.Html.
  46. Hayn, C. (1995). The information content of losses. Journal of Accounting and Economics, 20, 125–153.CrossRefGoogle Scholar
  47. Heeley, M., Matusik, S., & Jain, N. (2009). Innovation, appropriability and the underpricing of initial public offerings. Academy of Management Journal, 50, 209–225.CrossRefGoogle Scholar
  48. Hughes, P. (1986). Signaling by direct disclosure under asymmetric information. Journal of Accounting and Economics, 8(2), 119–142.CrossRefGoogle Scholar
  49. Jaffe, A., Trajtenberg, M., & Henderson, M. (1993). Geographic localization of knowledge spillovers as evidenced by patent citations. The Quarterly Journal of Economics, 108(3), 577–598.CrossRefGoogle Scholar
  50. Jaffe, A., Trajtenberg, M., & Fogarty, M. (2000). Knowledge spillovers and patent citations: Evidence from a survey of investors. The American Economic Review, 90(2), 215–218.CrossRefGoogle Scholar
  51. John, K., & Lang, L. (1991). Insider trading around dividend announcements: Theory and evidence. The Journal of Finance, 46(4), 1361–1389.CrossRefGoogle Scholar
  52. Jones, J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29, 193–228.CrossRefGoogle Scholar
  53. Joos, P., & Zhdanov, A. (2008). Earnings and equity valuation in the biotech industry: Theory and evidence. Financial Management, 37(3), 431–459.CrossRefGoogle Scholar
  54. Kothari, S. P. (2001). Capital markets research in accounting. Journal of Accounting and Economics, 31, 105–231.Google Scholar
  55. Kothari, S., Leone, A., & Wasley, C. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39(1), 163–197.CrossRefGoogle Scholar
  56. Kothari, K., Mizik, N., & Roychowdhury, S. (2016). Managing for the moment: The role of earnings management via real activities versus accruals in SEO valuation. The Accounting Review, 91(2), 559–586.CrossRefGoogle Scholar
  57. Leland, H., & Pyle, D. (1977). Information asymmetries, financial structure, and financial intermediation. Journal of Finance, 32, 371–387.CrossRefGoogle Scholar
  58. Lev, B., Sarath, B., & Sougiannis, T. (2005). R&D reporting biases and their consequences. Contemporary Accounting Research, 22(4), 977–1026.CrossRefGoogle Scholar
  59. Li, Y., & McConomy, B. (2004). Simultaneous signalling in IPOs via management earnings forecasts and retained ownership: An empirical analysis of the substitution effect. Journal of Accounting, Auditing, and Finance, 19(1), 1–28.CrossRefGoogle Scholar
  60. Marquardt, C., & Wiedman, C. (2004). How are earnings managed? An examination of special accruals. Contemporary Accounting Research, 21, 461–491.CrossRefGoogle Scholar
  61. Megginson, W., & Weiss, K. (1991). Venture capitalist certification in initial public offerings. Journal of Finance, 46, 692–712.CrossRefGoogle Scholar
  62. Morsfield, S., & Tan, C. (2006). Do venture capitalists influence the decision to manage earnings in initial public offerings? Journal of Accounting Research, 81(5), 1119–1150.Google Scholar
  63. Ohlson, J. (1995). Earnings, book values, and dividends in equity valuation. Contemporary Accounting Research, 11(2), 661–687.CrossRefGoogle Scholar
  64. Pakes, A., Hall, B., & Griliches, Z. (1998). The value of patents as indicators of inventive activity, National Bureau of economic research (NBER) working paper no.2083.Google Scholar
  65. Patatukas, P., Sloan, R., & Wang, A. (2016). Short-sales constraints and aftermarket IPO pricing. In Working paper. California at Berkeley: University of.Google Scholar
  66. Petersen, M. (2009). Estimating standard errors in financial panel data sets: Comparing approaches. Review of Financial Studies, 22(1), 435–480.CrossRefGoogle Scholar
  67. Ritter, J. (1984). Signalling and the valuation of unseasoned new issues: A comment. Journal of Finance, 39(4), 1231–1237.CrossRefGoogle Scholar
  68. Roychowdhury, S. (2006). Earnings management through real activities manipulation. Journal of Accounting and Economics, 42, 335–370.CrossRefGoogle Scholar
  69. Shivakumar, L. (2000). Do firms mislead investors by overstating earnings before seasoned equity offerings? Journal of Accounting and Economics, 29, 339–371.CrossRefGoogle Scholar
  70. Skinner, D. (2008). Accounting for intangibles – A critical review of policy recommendations. Accounting and Business Research, 38(3), 191–204.CrossRefGoogle Scholar
  71. Smith, C., & Watts, R. (1992). The investment opportunity set and corporate financing, dividend, and compensation policies. Journal of Financial Economics, 32(3), 263–292.CrossRefGoogle Scholar
  72. Srivastava, A. (2014). Why have the measures of earnings quality changed over time? Journal of Accounting and Economics, 57(2–3), 196–217.CrossRefGoogle Scholar
  73. Stubben, S. (2010). Discretionary revenues as a measure of earnings management. The Accounting Review, 85(2), 695–717.CrossRefGoogle Scholar
  74. Teoh, S., Welch, I., & Wong, T. (1998a). Earnings management and the long-run market performance of initial public offerings. Journal of Finance, 53, 1935–1974.CrossRefGoogle Scholar
  75. Teoh, S., Wong, T., & Rao, G. (1998b). Are accruals during initial public offerings opportunistic? Review of Accounting Studies, 3(1), 175–208.CrossRefGoogle Scholar
  76. Tobin, J. (1969). A general equilibrium approach to monetary theory. Journal of Money, Credit and Banking, 1, 15–19.CrossRefGoogle Scholar
  77. Trajtenberg, M. (1990). A penny for your quotes: Patent citations and the value of innovations. RAND Journal of Economics, 21(1), 172–187.CrossRefGoogle Scholar
  78. Trueman, B., Wong, M. H. F., & Zhang, X.-J. (2000). The eyeballs have it: Searching for the value in internet stocks. Journal of Accounting Research, 38, 137–162.CrossRefGoogle Scholar
  79. Wang, A. (2016). R&D overinvestment around seasoned equity offerings: Evidence from high-technology industries. Working paper, University of California at Berkeley.Google Scholar
  80. Zang, A. (2012). Evidence on the trade-off between real activities manipulation and accrual-based earnings management. The Accounting Review, 87(2), 675–703.CrossRefGoogle Scholar
  81. Zimmerman, J. (2015). The role of accounting in the twenty-first century firm. Accounting and Business Research, 45(4), 485–509.CrossRefGoogle Scholar
  82. Zingales, L. (2000). In search of new foundations. Journal of Finance, 55(4), 1623–1653.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2017

Authors and Affiliations

  1. 1.University of San FranciscoSan FranciscoUSA
  2. 2.HEC MontrealMontrealCanada
  3. 3.Marshall School of BusinessUniversity of Southern CaliforniaLos AngelesUSA

Personalised recommendations