Regulations, earnings management, and post-IPO performance: The Chinese evidence
1. Introduction
The development of stock market in China has paralleled the transition of Chinese economy from a planned economy to a market economy. To achieve the objective of establishing a lsquo;lsquo;socialist market economy”, the Chinese government announced its plan to transform the old state-owned enterprises (SOEs) into modern listed corporations in the early 1990s. Since then, many Chinese SOEs have been undergoing partial privatization through initial public offerings (IPOs) with the government retaining a substantial portion of ownership in the newly listed firms. Recent works find that these partially privatized Chinese SOEs generally perform worse after IPO (see Sun and Tong, 2003; Wang, 2005; Fan et al., 2007). By comparison, most studies on share issue privatization (SIP) worldwide, reviewed by Megginson and Netter (2001), report significant improvements in the operating and financial performance and positive long-term abnormal return following SIP. The continued Chinese governmentrsquo;s presence in the newly listed firms stands in sharp contrast to complete privatization prevalent in Russia, Eastern Europe or Latin America during a similar move by these countries towards a market economy. The vested interest that the Chinese government has in the success of SIP in turn has led to tight government regulations of the IPO process.
The purpose of this study is to examine whether government regulatory initiatives involving IPO by SOEs may have contributed to opportunistic reporting practices and forecasting behaviors by the issuer and poor long-run post-IPO performance. We focus on two sets of regulations governing IPO issued by the China Securities Regulatory Commission (CSRC) between January 1, 1996 and February 11, 1999. One is the pricing regulations, stipulating that the IPO price be given by the product of earnings per share (EPS) calculated over a pre-specified time period (labeled pricing-period hereafter) and a price-to-earnings (P/E) ratio. Under the pricing regulations, accounting performance (i.e., EPS) is a key determinant for the offering price and IPO firms may be motivated to inflate accounting performance to increase the IPO proceeds. The other set of regulations we focus on is the penalty regulations, introduced on December 26, 1996, penalizing firms whose realized earnings for the IPO year fall below the corresponding management earnings forecasts contained in the prospectus by 10% or more.
Our sample consists of 366 firms that did IPO between January 1, 1996 and February 11, 1999. We find that the overall IPO firms report a large decline in post-IPO profitability. The mean pricing-period ROA for the full sample is 15.62%, whereas the mean post-IPO ROA is only 8.39%.
Furthermore, the mean three-year post-IPO abnormal stock returns for all IPO firms are -23%, significant in both statistical and economic senses. Partitioning IPO firms into terciles based on the pricing-period accounting performance, we find that the post-IPO decline in profitability by the top-tercile firms exceeds that of the bottom- or middle- tercile firms. The mean decline in post-IPO ROA is 15.52% for the top-tercile firms, but only 4.53% and 1.62% for the middle- and bottom-tercile firms, respectively. Moreover, the former group has lower first-day stock returns and worse long-term post-IPO stock performance than the other two groups. Taking the three-year post- IPO abnormal returns, for example, the mean for the top-tercile firms is -45%, whereas that for the middle- (bottom-) tercile firms is -19% (-6%). Using non-core earnings as the proxy for earnings management, we document some preliminary evidence that IPO firms with better pricing-period accounting performance engage in relatively more income-increasing earnings management activities in the IPO year. Taken together, these results suggest that pricing regulations based on accounting earnings might have induced IPO firms to inflate pricing period earnings to increase IPO proceeds, which cause the decline in post-IPO profitability and poor post-IPO stock performance.
By comparison, penalties imposed by the government against overly optimistic earnings forecasts may have yielded a more positive effect on the behavior of IPO firms. Firms subject to penalty regulations are less likely to make penalizable forecast errors in the IPO year, compared to those before such regulations came into effect. We find that IPO firms that make overoptimistic earnings forecasts for the IPO year have significantly worse first-day stock returns and long-run post-IPO stock returns. Taking the three-year post-IPO stock returns, for example, the mean for IPO firms with realized earnings falling short of the forecast earnings by 10% or more is -43%, whereas that for IPO firms with realized earnings exceeding the forecast earnings by more than 10% is -12%. By reducing the percentage of IPO firms that fail to meet their forecast earnings by a large gap, penalty regulations have a positive impact on IPO firmsrsquo; performance.
To the best of our knowledge, we are the first research team to consider the potential role that government regulations may play in affecting a firmrsquo;s reporting practices and forecasting behavior surrounding IPO. Our findings suggest that poor IPO performance in China might be attributable to the not well-thought-out Chinese government regulatory initiatives. Our work extends prior research on the association between earnings management and IPO. Teoh et al. (1998a,b) found that US IPO firms manage earnings during their IPOs, but they tend to underperform in the long-run. Aharony et al. (2000) documented evidence of earnings management by Chinese firms in unprotected industries when they took B- or H-shares public during 1992–95. Unlike these studies, we are interested in how firms
剩余内容已隐藏，支付完成后下载完整资料
Regulations, earnings management, and post-IPO performance: The Chinese evidence
1. Introduction
The development of stock market in China has paralleled the transition of Chinese economy from a planned economy to a market economy. To achieve the objective of establishing a lsquo;lsquo;socialist market economy”, the Chinese government announced its plan to transform the old state-owned enterprises (SOEs) into modern listed corporations in the early 1990s. Since then, many Chinese SOEs have been undergoing partial privatization through initial public offerings (IPOs) with the government retaining a substantial portion of ownership in the newly listed firms. Recent works find that these partially privatized Chinese SOEs generally perform worse after IPO (see Sun and Tong, 2003; Wang, 2005; Fan et al., 2007). By comparison, most studies on share issue privatization (SIP) worldwide, reviewed by Megginson and Netter (2001), report significant improvements in the operating and financial performance and positive long-term abnormal return following SIP. The continued Chinese governmentrsquo;s presence in the newly listed firms stands in sharp contrast to complete privatization prevalent in Russia, Eastern Europe or Latin America during a similar move by these countries towards a market economy. The vested interest that the Chinese government has in the success of SIP in turn has led to tight government regulations of the IPO process.
The purpose of this study is to examine whether government regulatory initiatives involving IPO by SOEs may have contributed to opportunistic reporting practices and forecasting behaviors by the issuer and poor long-run post-IPO performance. We focus on two sets of regulations governing IPO issued by the China Securities Regulatory Commission (CSRC) between January 1, 1996 and February 11, 1999. One is the pricing regulations, stipulating that the IPO price be given by the product of earnings per share (EPS) calculated over a pre-specified time period (labeled pricing-period hereafter) and a price-to-earnings (P/E) ratio. Under the pricing regulations, accounting performance (i.e., EPS) is a key determinant for the offering price and IPO firms may be motivated to inflate accounting performance to increase the IPO proceeds. The other set of regulations we focus on is the penalty regulations, introduced on December 26, 1996, penalizing firms whose realized earnings for the IPO year fall below the corresponding management earnings forecasts contained in the prospectus by 10% or more.
Our sample consists of 366 firms that did IPO between January 1, 1996 and February 11, 1999. We find that the overall IPO firms report a large decline in post-IPO profitability. The mean pricing-period ROA for the full sample is 15.62%, whereas the mean post-IPO ROA is only 8.39%.
Furthermore, the mean three-year post-IPO abnormal stock returns for all IPO firms are -23%, significant in both statistical and economic senses. Partitioning IPO firms into terciles based on the pricing-period accounting performance, we find that the post-IPO decline in profitability by the top-tercile firms exceeds that of the bottom- or middle- tercile firms. The mean decline in post-IPO ROA is 15.52% for the top-tercile firms, but only 4.53% and 1.62% for the middle- and bottom-tercile firms, respectively. Moreover, the former group has lower first-day stock returns and worse long-term post-IPO stock performance than the other two groups. Taking the three-year post- IPO abnormal returns, for example, the mean for the top-tercile firms is -45%, whereas that for the middle- (bottom-) tercile firms is -19% (-6%). Using non-core earnings as the proxy for earnings management, we document some preliminary evidence that IPO firms with better pricing-period accounting performance engage in relatively more income-increasing earnings management activities in the IPO year. Taken together, these results suggest that pricing regulations based on accounting earnings might have induced IPO firms to inflate pricing period earnings to increase IPO proceeds, which cause the decline in post-IPO profitability and poor post-IPO stock performance.
By comparison, penalties imposed by the government against overly optimistic earnings forecasts may have yielded a more positive effect on the behavior of IPO firms. Firms subject to penalty regulations are less likely to make penalizable forecast errors in the IPO year, compared to those before such regulations came into effect. We find that IPO firms that make overoptimistic earnings forecasts for the IPO year have significantly worse first-day stock returns and long-run post-IPO stock returns. Taking the three-year post-IPO stock returns, for example, the mean for IPO firms with realized earnings falling short of the forecast earnings by 10% or more is -43%, whereas that for IPO firms with realized earnings exceeding the forecast earnings by more than 10% is -12%. By reducing the percentage of IPO firms that fail to meet their forecast earnings by a large gap, penalty regulations have a positive impact on IPO firmsrsquo; performance.
To the best of our knowledge, we are the first research team to consider the potential role that government regulations may play in affecting a firmrsquo;s reporting practices and forecasting behavior surrounding IPO. Our findings suggest that poor IPO performance in China might be attributable to the not well-thought-out Chinese government regulatory initiatives. Our work extends prior research on the association between earnings management and IPO. Teoh et al. (1998a,b) found that US IPO firms manage earnings during their IPOs, but they tend to underperform in the long-run. Aharony et al. (2000) documented evidence of earnings management by Chinese firms in unprotected industries when they took B- or H-shares public during 1992–95. Unlike these studies, we are interested in how firms
剩余内容已隐藏，支付完成后下载完整资料
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