The impact of investment banks going public on underwriting behavior: Evidence from IPO clients’ earnings management

Abstract

This study examines the economic incentive theory, positing that listed investment banks facing significant economic pressure are likely to compromise their underwriting quality to meet client demands. Analyzing Chinese IPO firms from 2006 to 2020, we observe that those underwritten by listed investment banks demonstrate more substantial earnings management compared to those underwritten by privately held banks. This tendency is more evident in scenarios where investment banks have stronger economic incentives, weaker corporate governance, and increased performance pressure. We also find that IPO firms underwritten by listed investment banks are likelier to pass the IPO screening by the China Securities Regulatory Commission and secure higher IPO prices through pronounced earnings management. Additionally, these firms show poorer post-IPO accounting performance and stock returns. Our findings suggest that the public listing of investment banks can compromise the impartiality and quality of their services as gatekeepers in the capital market, particularly in emerging markets with limited shareholder rights protection. These results underscore the need for investors, stakeholders and regulators to be vigilant about the potential compromise to the independence of investment banks following their public listings.