The effect of prestigious underwriters and their affiliated venture capitalist businesses on earnings management and underpricing of IPO issuers

Abstract

Existing empirical findings on the role of prestigious underwriters and their affiliated venture capitalist businesses in restraining earnings management and influencing the underpricing of initial public offering (IPO) issuers are mixed. This study presents a positive effect by prestigious underwriters in constraining issuer earnings management in an emerging market, which supports the "certification" hypothesis. However, a pre-IPO investment by a prestigious underwriter's affiliated venture capitalist mitigates the independent and certified roles of the reputable underwriter, suggesting conflicts of interest. Set in the transforming of Chinese market, this study finds that in a weak monitoring environment, the significance of the positive relationship between an underwriter's reputation and an issuer's earnings quality will be alleviated by a pre-IPO investment by the prestigious underwriter's affiliated venture capitalist. The empirical results show that both the reputable underwriter and its affiliated venture capitalist negatively affect the underpricing of the IPO issuer, supplying more evidence for conflicts of interest. The firms who receive the prestigious underwriter's affiliated venture capital are associated with poorer stock price performances, measured by cumulative market-adjusted compound stock returns, and worse accounting performances, measured by post-IPO earnings growth, sales growth, and the change in returns on sales. The results in this paper indicate that a pre-IPO investment by the prestigious underwriter's affiliated venture capitalist business damages the certification of the reputable underwriter and destroys shareholder value.

Date of Award	15 Jul 2014
Original language	English
Awarding Institution	City University of Hong Kong
Supervisor	Chansog KIM (Supervisor), John K COURTIS (Co-supervisor), Grant Andrew RICHARDSON (Supervisor) & Zhifeng YANG (Co-supervisor)