Are private equity sponsors guarantee of IPO quality?
School of Business | Master's thesis
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AbstractI assess earnings management in the pre-IPO year in private equity (PE) backed, venture capital (VC) backed and non-backed initial public offerings. I examine, if the PE and VC sponsors limit the pre-IPO earnings management, and if the sponsors are related to higher long-run performance of the issuers. I hypothesize that PE and VC sponsors have motives to promote high corporate governance standards and to limit opportunistic behavior in issuing companies to preserve their reputation. I also address earnings management’s effect on IPO underpricing and the long-run return of issuers. Finally, I explore the effect that interaction of pre-IPO earnings management and PE or VC sponsoring has on long-run performance of the issuer. My sample consists of 681 IPOs in the US between 2004 and 2018. I use pre-IPO year abnormal accruals (AAC) from the modified Jones model as a measure of earnings management. As a measure of long-run performance, I use three-year after-IPO monthly average abnormal stock returns (AAR) and three-year buy-and-hold abnormal stock returns (BHAR), which I estimate in relation to industry benchmark portfolios and with the Fama-French three-factor model. The key statistical tests are three groups of multiple linear regression models in which the dependent variables are the AAC measure, first day return, and the three-year abnormal return measures. The primary independent variables are indicator variables of PE and VC sponsoring, abnormal accruals, and interaction variables of the PE and VC variables and the AAC measure. I find evidence of PE sponsors reducing abnormal accruals of the issuers by approximately 4ppt, and PE-backed IPOs being related to 21% to 31% higher BHAR when comparing to non-backed IPOs. This is consistent with Cao & Lerner (2009), who report BHAR of 5% for RLBOs, and -7% for non-backed IPOs. However, I do not find statistically significant relation between venture capital sponsoring, and lower EM or higher long-run performance after controlling for IPO characteristics, even though VC sponsored IPOs have lower average abnormal accruals and higher average three-year abnormal returns than non-backed issuers. Ritter (1991) famously reports underperformance of IPOs, whereas I find no evidence of IPOs as a group underperforming, but link underperformance to non-backed IPOs. Also, I find pre-IPO EM having negative effect on long-run performance. My results imply that a 10ppt increase in AAC would decrease the average monthly abnormal return by 0.11 to 0.13ppt and BHAR by 4ppt to 10ppt. Similarly, Teoh et. al. (1998), find 20% weaker BHAR for IPOs in most aggressive quartile of EM compared to the most conservative quartile. I do not find significant difference in underpricing of PE, VC, and non-backed IPOs after controlling for IPO characteristics. Finally, I do not find evidence of difference in the effect that earnings management in PE or VC backed companies has on long-run performance of the issuer compared to earnings management in non-backed issuers, but this topic provides interesting setting for future research.
Thesis advisorTorstila, Sami
private equity, venture capital, earnings management, IPO, performance, underpricing