Do IPO Firms Misclassify Expenses? Implications for IPO Price Formation and Post-IPO Stock Performance

Xiaotao (Kelvin) Liu () and Biyu Wu ()
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Xiaotao (Kelvin) Liu: D’Amore-McKim School of Business, Northeastern University, Boston, Massachusetts 02115; Division of Economic and Risk Analysis, Securities Exchange Commission, Washington, D.C. 20549
Biyu Wu: School of Accountancy, College of Business, University of Nebraska-Lincoln, Lincoln, Nebraska 68588

Management Science, 2021, vol. 67, issue 7, 4505-4531

Abstract: This study investigates whether initial public offering (IPO) firms inflate “core” earnings through classification shifting (i.e., misclassifying core expenses as income-decreasing special items) immediately prior to IPOs. We provide initial evidence that IPO firms engage in classification shifting in the pre-IPO period. Using hand-collected price and share information from IPO prospectuses, we find that pre-IPO classification shifting is positively associated with a price revision from the midpoint of the initial price range to the final offer price, suggesting that pre-IPO classification shifting influences IPO price formation. Furthermore, we find that pre-IPO classification shifting is negatively associated with post-IPO stock returns. Overall, our findings caution investors, auditors, and regulators that classification shifting, a seemingly innocuous accounting maneuver, can mislead investors in their IPO valuation and is associated with post-IPO underperformance.

Keywords: IPO; classification shifting; special items; price formation; post-IPO stock performance (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:67:y:2021:i:7:p:4505-4531

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