Earnings Management: Accounting Policy Choices before Going Public

Companies that go public do not have market determined prices for those shares. There is high information asymmetry between the management of a company and the potential investors. These companies have to publish prospectuses that contain historical financial statements. With this information the final offering price is determined by the underwriter and preliminary response from investors. However through the high information asymmetry management has the possibility to manage the earnings in the historical financial statements. This can be done by choosing accounting policies that positively affect the income in the financial statements. Therefore a research is done among 33 Dutch companies that went public in the period from 1997 to 2004. This research examines if companies use accounting policies aggressively before going public. For the research a model is developed to objectively categorize each of the accounting policies. After gathering and analysing the data the research discovered that almost 76 percent of the companies used income-increasing accounting policies before going public. Next to this high percentage other indicators indicate that there is a positive association between the aggressive use of accounting policies and going public.