The Effect of Monitoring Mechanisms on Optimism in IPO Management Earnings Forecasts

• In Event: Disclosure

Abstract

Many different parties are interested in identifying and understanding either intentional or unintentional bias (usually overstating) earnings or predicted earnings. In this study we examine the optimistic bias in management forecasts of companies with an initial public offering (IPOs) in the year of their initial IPO and in the subsequent two years. We compare the IPO management forecast bias with the management forecast bias of Non-IPO firms. While one might expect IPO companies to exaggerate their prospects in order to help raise capital at the time of the IPO, this optimistic bias continues even after the IPO has occurred. In addition, our study examines whether monitoring factors (auditor type, percentage of independent board members, the percentage of institutional investors, and industry litigation risk) are successful in reducing the optimism in the management earnings forecasts of IPO firms. Consistent with our expectations, IPO companies are significantly optimistic in their management earnings forecasts in the year of the initial IPO and in the subsequent two years where they continue to be raising capital. Of particular interest, while IPO management forecasts remain optimistic, the monitoring mechanisms are associated with a reduction in the degree of optimism beyond the ‘normal’ effect found for both companies in general across both the year of the IPO and the following years when the IPO continues to raise capital.

Authors

• David A Ziebart, University of Kentucky

• Yu-Ho Chi, University of Tennessee at Martin