Is better corporate governance beneficial for firms at IPO?

When a firm plans to IPO, they must create a prospectus for potential investors. Firms have the option of including an earnings forecast in this document. The goal of this research is to determine whether better corporate governance provides improved information to potential investors.

What you need to know:

Firms at IPO can choose whether to include a forecast in their prospectus. Firms with good corporate governance tend not to include a forecast and those that do tend to use discretionary accruals to manage their earnings in the year of their IPO. Improved corporate governance appears to encourage a firm to act more conservatively and this leads to improved predictability of their future cash flows.

More Details:

What did the researchers do?

Denis Cormier, Pascale Lapointe-Antunes and Bruce McConomy asked:

  1. do corporate governance factors help differentiate forecasting IPO firms from non-forecasting firms;
  2. do IPO firms manage earnings in the year of going public, and if so, is this affected by actual earnings and stronger corporate governance environments; and
  3. is the predictive value of discretionary accruals higher for firms with better corporate governance?

The team conducted a review of past articles followed by a study of 301 firm IPOs on the Toronto Stock Exchange.

What did the researchers find?

The research team found that firms with better corporate governance are less likely to include a forecast in their IPO prospectus. Their findings suggest that non-forecasting firms act more conservatively in their prospectus to avoid the risks associated with not achieving their predicted results.

Firms that do forecast are more likely to use discretionary accruals in the year of their IPO to meet their forecast. These accruals are positively associated with future cash flows. Firms can use discretionary accruals to share information with investors about next year’s accruals, leading to better future cash flows due to increased predictability.

Corporate governance practices therefore impact not only the decision to forecast, but also the use of earnings management via discretionary accruals. Firms with better corporate governance act more conservatively and create better information for investors, improving predictability of their results.

How can you use this research?

Regulators can use this research to strengthen corporate governance requirements to improve the predictability of firms at IPO.

Investors can use this research to examine discretionary accruals more closely to determine their impact on the ability of the firm to meet its forecast.

Want to know more?

Contact Bruce McConomy

Article citation: Cormier, D., Lapointe-Antunes, P., McConomy, B. (2014). Forecasts in IPO Prospectuses: The Effect of Corporate Governance on Earnings Management. Journal of Business Finance & Accounting, 41, 1 & 2, pp. 100-127.

Megan Hall

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Megan Hall