Does Investment Bankers’ Prior Experience in Public Accounting Reduce Earnings Management in IPO Firms?

• In Event: Auditor Expertise and Experience

Abstract

We examine whether firms undertaking an initial public offering (IPO) exhibit less earnings management when individual investment bankers have prior experience in public accounting. Although auditors are primarily responsible for providing external monitoring of the financial reporting process, individual bankers also have strong incentives to improve accounting quality in firms going public. We predict a negative relation between public accounting experience and IPO firms’ earnings management given that working as an auditor fosters individual bankers’ accounting expertise and conservative personalities. In exploiting unique disclosures of investment bankers’ identities and characteristics in China, our analysis indicates that individual bankers with early-career experience as auditors constrain issuer firms’ earnings management through both accruals and real activities. Consistent with expectations, we find that this evidence is more pronounced if the audit firm that employed the future investment banker is larger; has expertise in the industry in which the IPO firm operates; is permitted to audit listed companies; and was previously subject to a regulatory sanction. Collectively, our analysis implies that public accounting practice experience is valuable for financial intermediaries, particularly when this experience stems from working at a high-quality audit firm.

Authors

• Xianjie He, Shanghai University of Finance and Economics

• Jeffrey Pittman, Memorial University of Newfoundland

• Sarah E Stein, Virginia Tech

• Huifang Yin, Shanghai University of Finance and Economics