| This dissertation investigates, both theoretically and empirically, how earnings management and ownership retention interact and how these two jointly affect the equilibrium market valuation of IPO firms in the presence of information asymmetry.; Analytically, this paper extends the univariate signaling framework of Leland and Pyle (1977) and derives an efficient signaling equilibrium in which both reported earnings and ownership retention are endogenously chosen to convey the IPO issuer's private information. It is shown that even though either ownership retention or reported earnings communicates the issuer's type to the market unambiguously, the issuer will strategically employ both signals to achieve separation at minimal cost. Comparative statics analysis also shows that the trade-off between the two signals depends critically on the uncertainty over future earnings.; The theoretical analysis generates several empirical implications regarding market efficiency, IPO pricing and the strategic choice of earnings management. These hypotheses are then empirically tested using a sample of IPO firms that went public during 1987--1997. I first reexamine the robustness of the results in Teoh et al. (J. Finance, (1998)) and Teoh et al. (Review of Accounting Studies (1998)). Using accruals directly calculated from cash flow statements and various stock performance benchmarks, I find that (1) discretionary accruals are the highest in the IPO year and are negatively correlated with future earnings decline, and (2) there is no consistent evidence that the issue year discretionary accruals and post-issue abnormal stock performance are negatively correlated, suggesting that the investors rationally discount IPO firms' reported earnings to arrive at the correct valuation of the firm. I then directly test the valuation implications of my model and find that both earnings and ownership retention are strongly positively priced in valuing an IPO firm. Finally, I examine whether riskier IPO firms resort more to income-increasing earnings management and retain less ownership, and the empirical evidence supports the above prediction. |
