THE EFFECTS OF UNDERWRITER REPUTATION ON
PRE-IPO EARNINGS MANAGEMENT AND
POST-IPO OPERATING PERFORMANCE
Yong Sun, Southwestern University of Finance and Economics, China
Kyung Joo Lee, University of Maryland-Eastern Shore
Diane Li, University of Maryland-Eastern Shore
John Jongdae Jin, California State University-San Bernardino
The purpose of this study is to investigate whether underwriters play any systematic and
significant role for IPO issuers. More specifically, we hypothesize that there is a negative relation
between underwriter reputation and earnings management before an IPO (certification role) and
that there is a positive relation between underwriter reputation and firm operating performance
after an IPO (monitoring role). Using a sample of 369 IPO’s over six-year period (1997-2002), we
find that high-reputation underwriters are associated with less earnings management before an IPO.
We also find that IPO issuers with high-reputation underwriters exhibit better post-IPO operating
performance after controlling for pre-IPO earnings management. These results support our
hypotheses, and are robust across different measures of variables and testing methodologies,
including an instrumental variable two-stage least square 2SLS) regression and a weighted least
square (WLS) regression.
The information asymmetries between IPO issuers and outside investors are considerable.
Under this condition, IPO issuers may seek to increase their offering proceeds through
manipulations of reportable earnings before going public. A stream of prior studies shows that IPO
issuers employ opportunistic earnings management before issuing IPOs to obtain some gains,
including enhancing initial firm values (e.g. Schipper 1989; Chaney and Lewis 1995; Teoh et al.
1998a, 1998b; Ducharme et al. 2001). For example, Teoh et al. (1998b) find evidence that IPO firms,
on average, have high positive issue-year earnings and discretionary accruals, followed by poor
long-run earnings and negative discretionary accruals.
However, prior studies on IPO earnings management have largely overlooked the potential
roles played by underwriters. Ducharme et al. (2001) include both underwriter reputation and
discretionary accruals as explanatory variables of IPO initial firm value, but they have not examined
Academy of Accounting and Financial Studies Journal, Volume 14, Number 2, 2010
the relation between un