Earnings Management, Managerial Optimism, and IPO Valuation

Abstract

We postulate that both managerial overoptimism and earnings management using accruals to boost accounting numbers effect on initial public offering (IPO) valuation. Referring to Purnandam and Swaminathan [2004], we gauge the IPO intrinsic values with respect to the offer price and the initial price. The portion that real offer (initial) price is above the intrinsic offer (initial) price is defined as offer premium (overreaction). Using 287 Taiwan's IPOs in sampling period 2004–2008, we find that most IPO firms were overpriced rather than underpriced. The offer premium is neither affected by earnings management nor managerial optimism, which is probably due to the greater scrutiny by the associated underwriters who are less gullible to managerial optimism or earnings management. In contrast, in initial market price valuation investors are cautious to take the face value of earnings management when IPO managers are perceived of moderate optimism. However, investors directly discipline overoptimistic managers with a lower initial valuation. Managerial overoptimism is the dominant factor in explaining long-run underperformance. We find that offer premium is positively associated with overreaction. Moreover, earnings management, albeit unrelated to overoptimism and offer premium, is positively related with initial overreaction and long-run underperformance.