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Review of Quantitative Finance and Accounting

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01.07.2011 | Original Research

Behavioral theories and the pricing of IPOs’ discretionary current accruals

verfasst von: Xu Li

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 1/2011

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Abstract

The main purpose of this paper is to provide additional evidence about the effect of discretionary current accruals on the pricing of IPOs. This paper seeks to discriminate between two alternative explanations for the prior findings: (1) behavioral biases coupled with limited arbitrage; and (2) the sample- and period-specific nature of the results in the prior literature. The IPOs from 1962 to 1998 were used to obtain the following results. First, there was not a negative association observed between discretionary current accruals and subsequent price performance for the 1926–1971 period. Second, analysis reveals that the pattern of cross-sectional evidence is inconsistent with the predictions made by behavioral theories. Third, in the 1972–1998 period, evidence of predictable negative performance attributable to IPO discretionary current accruals is limited to NASDAQ firms. These findings are difficult to reconcile with the explanation of behavioral biases coupled with limited arbitrage.

Vorheriger Artikel Can long-term performance plans mitigate the negative effects of stock consideration and high cash for acquirers?

Nächster Artikel Entrenched controlling shareholders and the performance consequences of corporate diversification in Taiwan

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Earnings are important to price IPOs worldwide. For example, Firth, Li and Wang (2008) find that earnings play an important role in valuing IPOs even in emerging capital markets.

Since the SDC database does not cover this early period, I adopt the Fama and French (2004) method of identifying IPOs. Strictly speaking, these firms should be called newly listed firms. However, Dharan and Ikenberry (1995) show that there is a long-run negative drift of post-listing stock returns, which provide evidence that newly listed firms are similar to IPOs in terms of long-run performance. Furthermore, this method of identifying IPOs has been used by other researchers in IPO studies. For example, Pastor and Veronesi (2005) use the same way to identify IPOs. Finally, I randomly cross-check ten newly listed firms from CRSP with A Decade of Corporate and International Finance—A Joint Project of Investment Dealers’ DIGEST and Investment Bankers Association and find eight of them to be really IPOs.

Although the SDC database covers 1970 through 1979, its coverage is fairly poor. As Fig. 2 shows, the number of IPOs identified by the SDC database cannot be the correct number. Therefore, I use CRSP to supplement this period’s sample.

In order to facilitate a comparison of market capitalization across time, I gather the inflation data from the website of the Department of Labor and all the market capitalization numbers are in million dollars in the purchasing power of 1997.

Kothari, Leone, and Wasley (2005) suggest that performance matching is crucial to the design of well-specified tests based on discretionary accruals. I adhere to the potentially problematic measure of discretionary current accruals, because my motivation in this study is to find the explanation for the anomaly documented in prior literature. Indeed, by showing the anomaly is not pervasive, I provide indirect evidence that the model of discretionary current accruals in Teoh, Welch, and Wong (1998) might not be well-specified.

I acknowledge that the tests of H1a are not perfect. For example, the identification of IPOs in the earlier time period may introduce noise and/or the measures of IPO discretionary accruals are not exactly the same as previous literature due to the lack of data in earlier time periods. However, the tests still provide additional evidence and the conclusions of the paper is not driven by only tests of H1a.

According to the CRSP data manual, on NASDAQ volumes of after-hours trades are included in the current day, while the trades or quotes are included the next day. Therefore, share turnover of NASDAQ firms is overstated compared with that of NYSE and AMEX firms. However, the share turnover of NASDAQ firms is still high even when the difference in computation is taken into consideration.

Considering the possibility that accounting numbers might be more reliable after SEC is set up, I also examine the pricing of DCA on an IPO sample from 1934 to 1961. The result has not changed, since the t-statistic of the coefficient on DCA in this sample is -0.70. Therefore, the coefficient is not significantly different from 0, indicating no mispricing of IPOs’ discretionary current accruals during this period.

Look-ahead bias has been introduced in the tests of H1b, however, it bias against finding evidence inconsistent with behavior explanations. For example, if high institutional ownership is associated with better return, the portfolios with lowest institutional ownership should have lowest return. Therefore, we should be more likely finding mispricing of DCA in this portfolio, since the mispricing is a long-term underperformance phenomenon. The fact that mispricing is happened in the highest institutional ownership portfolio makes the look-ahead bias less of a concern.

Number of analysts following may suffer an endogenous problem in the sense that high likelihood of misevaluation on a stock can attract more analysts to follow the stock. However, if that is the case, behavioral models should be careful to generate implications related to number of analysts following. The potential endogenous problem does not affect my test of implications of behavioral models.

The IPOs on the AMEX from 1962 to 1979 are marginally mispriced, but the result is further weakened after controlling for the three Fama–French factors.

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Titel: Behavioral theories and the pricing of IPOs’ discretionary current accruals
verfasst von: Xu Li
Publikationsdatum: 01.07.2011
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 1/2011
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-010-0196-x

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