Question

Explain the findings of Teoh, Welch and Wong (1998) in relation to abnormal accruals in IPO years.

Answer 1

Before I discuss the findings of Teoh, Welch and Wong in relation to abnormal accruals, lets discuss what are accruals are at first. Accurals are the revenue earned or expenses incurred on the companies net income or the income statement. The accruals tends to affect the balance sheet, as they involve the non cash asset and liabilities. Accurals are created by adjusting the journal entries at the end of the each accounting period.

Teoh, Welch and Wong (2002) study is of significant understanding. The study done in 2002 reveals the existence of severe aftermarket underperformance for issuers. This phenomenon was been reported in the U.S. and in other countries. In the year of 2004, the study provide evidence that earnings management can at least in part explain the aftermarket performance of public equity issues. The same researchers in 2006 investigated whether the earnings management explanation for the long-term stock performance of public issues also holds for equity private issues. Their results suggest that Discretionary Current Accruals (DCA) predict the cross-sectional variation in post-IPO long-term stock return performance. The study also suggested that the ‘Aggressive’ earnings management companies, with higher income-increasing accruals in the IPO year, experience poorer stock return performance in the 3 post-IPO years than ‘conservative’ earnings management companies. Roosenboom, van der Goot and Mertens found a similar negative relationship later on.