Accounting Method Choice and IPO Valuation.

Abstract The importance of accounting disclosures in the market for new issues is underscored by the lack of publicly available information about the firms. In this paper we study the accounting method choices accompanying the initial offerings of 505 companies. Using regression analysis, the method choices of the sample firms are examined with regard to two observable market effects, the initial offering proceeds and the underpricing of the issues. Two relationships between accounting method choice and the pricing of initial offering firms are analyzed. First, accounting choice is viewed as a means by which issuers may affect the proceeds of the initial offering. Our results indicate a marginally significant positive association between the initial proceeds from an offering and the selection of accounting methods that result in larger income and asset values. Second, we focus on the relation between accounting method choice and the underpricing of initial offerings, a phenomenon occurring when the initial offering price appears to be set systematically low, relative to subsequent traded values. It is suggested that accounting choices that enhance reported income and asset values are likely to be associated with greater risk of litigation against the underwriters and issuers of the securities. Because of this increased risk of litigation, it is hypothesized that initial offering firms making these accounting choices are subject to greater underpricing, as underwriters and issuers attempt to limit their exposure. Our results are consistent with this hypothesis.