The performance of Malaysian initial public offerings and earnings management

Abstract

An initial public offering (IPO) of equity provides a significant source of finance for Malaysian companies. Due to the existence of inequalities of wealth within Malaysian society as a result of its colonial heritage, the government has used IPOs to redistribute wealth among ethnic groups with the main objective being to increase the involvement of the Bumiputera (local indigenous people) in the corporate sector. This thesis consists of three inter-related studies on Malaysian IPOs that were listed on the Bursa Malaysia (formerly known as the Kuala Lumpur Stock Exchange) during the period 1990 to 2000. In particular, this study investigates post-IPO performance using alternative performance approaches (market-based and accounting-based) and the earnings management explanation for observed performance. The results from the first study indicate that Malaysian IPOs significantly overperform their benchmarks when performance is measured using both equally-weighted cumulative abnormal returns (CARs) and buy-and-hold abnormal returns (BHARs), except when matched companies are used as the benchmark. However, this significant overperformance disappears when returns are calculated on a value-weighted basis and also when Fama-French (1993) three-factor regressions are employed. Cross-sectional analysis reveals differential performance related to year of listing, issue proceeds and initial returns. The results from the second study using accounting-based measures provide strong evidence of declining operating performance in the IPO year and up to three years following an IPO. The year-to-year analysis reveals that the declining performance is greatest in the year immediately following the IPO. The deterioration in performance is more pronounced when accrual-based operating performance measures are used. The difference in the results using accrual-based and cash flow-based approaches suggests the existence of earnings manipulation by the IPO manager. The investigation of the possible sources of operating performance changes suggests that post-IPO declines in asset turnover parially explain the poorer operating performance. Univariate analysis of the association between family relationships, retained ownership and post-IPO operating performance produces little evidence to explain the deterioration in operating performance. However, underpricing partially explains the deterioration when the cash flow-based performance measure is used. The results from the third study reveal that Malaysian IPO companies employ income-increasing strategies around offerings, and that these strategies were more prevalent during the East Asian crisis period, especially for those companies that provided a profit guarantee. Analysis of the assöciation between the magnitude of earnings management in the IPO year and post-IPO performance provides some evidence to support the view that aggressive earnings management at the time of an IPO subsequently leads to poor stock market and operating performance. Overall, the evidence in this thesis supports the consensus that has emerged from the international debate on studies involving long horizon returns, which suggests that the magnitude of long run performance depends on the method employed to measure performance. The evidence derived from the accounting-based measure of operating performance supports the existing international evidence that operating performance declines following IPOs. The results also provide a degree of support for the earnings management explanation of post-IPO performance. These findings have implications for investors, security analysts, companies and accounting standard setters.