Financial Sponsors: Friend or Foe in an IPO? Earnings management in Nordic initial public offerings

Abstract: In this study, I examine the extent of earnings management in Nordic initial public offerings ("IPOs") and the impact of third-parties, with emphasis on financial sponsors (private equity, venture capital and family-owned investment companies). In an IPO, insiders have incentives to manipulate earnings in order to maximize the monetary gain when they divest their shares. Previous research has found that IPO firms tend to manipulate earnings to a higher extent than comparable firms, but that highly reputable third-parties can mitigate earnings management due to increased monitoring and the possibility for firms that engage in less manipulation to signal quality through engaging such advisors. I follow previous research and apply discretionary current accruals as a proxy for earnings management on a sample of 138 IPOs between 2010-2014 as well as 719 private companies in the Nordics. I provide evidence that supports a higher level of manipulation among IPO firms than comparable private companies. Contradictory to previous research, I find a positive relationship between earnings management and financial sponsors, which is further increased if a top underwriter is engaged in the IPO, whereas the impact of top underwriters in isolation is found insignificant. These findings support that financial sponsors engage in higher extents of earnings management in order to increase their financial gain in the IPO. Consistent with previous studies, I further find a decreasing relationship between earnings management and legal advisors as well as financial sponsors that can be considered more credible. I conclude that the first is a result from signaling and the latter a consequence from monitoring conducted by the credible sponsor, which limits the ability to manipulate earnings.