Valuation and Underpricing of Initial Public Offerings: Role of Discretionary Accounting Accruals

This study examines the role of pre-IPO discretionary accruals in the valuation and underpricing of IPOs. We find that IPO offer price is unaffected whereas market closing price is positively associated with the levels of pre-IPO discretionary accruals for issuers with aggressively reported earnings. We also find that this relative over-valuation of managed earnings by the markets explains a portion of the initial return that is not explained by other known determinants. For issuers with conservatively reported pre-IPO earnings, there is no relation between discretionary accruals and the offer price or the market price, and the discretionary accruals do not explain any IPO underpricing. These findings suggest that markets do not seem to understand the implications of aggressively reported earnings on pricing of IPOs.