IPOS in China : an empirical study of performance, returns, and earnings manipulation

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IPOS in China : an empirical study of performance, returns, and earnings manipulation


Author: Ng, Lai-man Carmen
Title: IPOS in China : an empirical study of performance, returns, and earnings manipulation
Degree: D.B.A.
Year: 2003
Subject: Hong Kong Polytechnic University -- Dissertations
Going public (Securities) -- China
Corporate profits -- China
Department: Graduate School of Business
Pages: viii, 83 leaves ; 30 cm
Language: English
InnoPac Record: http://library.polyu.edu.hk/record=b1737694
URI: http://theses.lib.polyu.edu.hk/handle/200/350
Abstract: Recent financial scandals have raised important questions regarding the integrity of accounting and financial statements. Stakeholders are increasingly concerned about the problems of earnings management and income manipulation. Earnings management is the process by which management borrows (overstates income), and banks (understates income) to reflect strategically convenient earnings. Management exercises its discretionary power to make use of the flexibility available to it, by choosing accounting policies - under generally accepted accounting principles - to achieve particular financial targets. Income is thus a measure that can be affected by the discretionary decisions of management. However, despite the subjective nature of earnings, there is ample evidence to suggest that capital markets are sensitive to both earnings and cash flow, and that investors tend to find incremental information in accruals (Dechow (94), Dechow, Sloan, & Sweeney (1995)). Haw, Qi & Wu (2001) also find that in the Chinese markets, earnings and accruals provide incremental information that is captured in returns. Aharony et al. (1993) found some evidence of the occurrence of earnings management for the period prior to Initial Public Offerings (IPOs) in the US, through the use of positive discretionary accruals in order to opportunistically inflate earnings. However, there is no study that has investigated the use of earnings management through discretionary accruals prior to IPOs in China, and its relationship to initial day returns. The requirement that listed companies maintain profitable operations in China further creates pressure on Chinese listed companies to manage earnings through discretionary accruals. However, China's accounting rules allow less room for managerial discretion, and thus less opportunity for earnings management. This study employs the Jones model and Dechow's modified Jones model to investigate the information content of accruals (discretionary and non-discretionary) as reflected in returns in the Chinese market. We find that in China, even though there is less opportunity for earnings management, pre-IPO accruals have significant informative value in explaining first day and first year adjusted returns. Non-discretionary accruals and discretionary accruals are both found to have significant information content in the initial day IPO returns. This study does not find any significant incremental information regarding discretionary versus non-discretionary accruals pre-IPO, consistent with the findings of Haw et al. (2001) in post-IPO firms in China. Interestingly, however, this study finds that on average, discretionary accruals in prospectus information pre-IPO are negative. This downward manipulation or income "understatement" creates initial under-pricing and abnormally high initial IPO returns for A shares. This significant finding explains Chan, Wang & Wei's (2003) conclusion that the "phenomenal" initial returns of A share IPOs, are subsequently followed by long-term under-performance. The results of this study confirm the use of opportunistic earnings management through discretionary accruals to understate earnings in the pre-IPO prospectuses of A shares in China, creating abnormally high returns on the first day of trading.

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