Earnings Quality and International IPO Underpricing

Thomas J. Boultona,*, Scott B. Smartb, Chad J. Zutterc

a
Farmer School of Business, Miami University, Oxford, OH 45056, USA
b
Kelley School of Business, Indiana University, Bloomington, IN 47405, USA
c
Katz Graduate School of Business, University of Pittsburgh, Pittsburgh, PA 15260, USA

Draft: July 2009

Abstract

Examining 7,306 IPOs from 34 countries, we find that IPOs are underpriced less in countries
where existing public firms produce higher quality earnings information. This finding persists
after controlling for other deal- and country-specific factors that affect IPO underpricing, and it is
driven neither by the large and relatively transparent markets in the U.S. and U.K. nor by the
relatively opaque Japanese market. The impact of going public in a country with relatively low
earnings quality is partially offset by the use of a high-quality underwriter.

JEL classification: G15; G24; G30; G32; G34

Keywords: international finance; earnings quality; initial public offerings; underpricing.

Data Availability: Data used in this study are available from public sources.


For valuable comments, the authors express their thanks to Oya Altinkiliç, Utpal Bhattacharya,

Robin Grieves, Robert Jennings, Kenneth Lehn, Gershon Mandelker, Jay Ritter, Shawn Thomas, Greg

Udell, Xiaoyun Yu, and seminar participants at Central Michigan University, Duquesne University,

Financial Management Association meetings (Orlando), Louisiana Tech University, Marquette University,

Miami University, Oklahoma State University, Seton Hall University, Texas A&M University, University

of Nebraska, University of Oklahoma, University of Otago, University of Pittsburgh, West Virginia

University, and Wright State University. Any remaining errors or omissions remain the responsibility of the

authors.

* Corresponding author. Tel.: + 1-513-529-1563; fax: + 1-513-529-8598.

E-mail address: boultotj@muohio.edu (T. Boulton).

Page 1
 I. Introduction

Few corporate events garner more attention from researchers, practitioners, the media, and

the public than initial public offerings (IPOs). Generally, the focus is on the large, sometimes

spectacular, first-day gains to new issues observed not only in the U.S., but in virtually all of the

ZRUOG¶s stock markets. Summarizing the findings of dozens of papers, the majority of which

focus on underpricing in a single country, Loughran et al. (1994) confirm that IPOs earn positive

first-day returns everywhere, and that underpricing varies dramatically across countries. What

drives underpricing differences across markets is still a largely unexplored question.

Theoretical explanations of the underpricing phenomenon often propose that underpricing

arises from information asymmetries between participants in the IPO process. To cite just one

prominent example, Rock (1986) shows that when investors have different information sets,

underpricing is necessary to induce less informed investors to bid for IPO shares in equilibrium.1

In a recent survey of the empirical evidence, Ljungqvist (2007) concludes that information

asymmetries ³KDYHDILUVW-RUGHUHIIHFWRQXQGHUSULFLQJ´7KXVLWLVQDWXUDOWRDVNZKHWKHUVRPHRI

the cross-country underpricing variation documented in the literature may be driven by

differences in the quality of information available to investors in different markets. Specifically,

we are interested in whether international differences in the quality of accounting information

help explain the international cross-section of IPO initial returns.

1
Other information-based underpricing theories endow different participants in the IPO process with

superior information. For example, in Baron (1982) investment bankers know more about an IPO firm¶s

true value than the issuer does, and underpricing becomes a solution to the resulting principal-agent

problem. In Allen and Faulhaber (1989), Grinblatt and Hwang (1989), and Welch (1989), issuers use their

information advantage to signal firm quality, whereas in Benveniste and Spindt (1989), underpricing

induces well-informed investors to reveal what they know before the offer price is set.

2
 The accounting and finance literatures confirm that earnings quality influences a range of

capital market outcomes. For example, Bhattacharya et al. (2003) find that in countries with

greater earnings opacity, firms face a higher cost of capital. Biddle and Hilary (2006) establish

that better accounting information leads to more efficient firm-level investment decisions,

particularly in countries where financing comes through arms-length transactions rather than

through relationships with creditors. Gelos and Wei (2005) find that emerging markets mutual

fund managers invest more heavily in countries with greater transparency. Jin and Myers (2006)

argue that greater opacity leads to lower firm-specific risk borne by investors and higher R-square

values.

These findings, combined with the central role that information asymmetries play in IPO

underpricing, give rise to our earnings quality hypothesis²do firms endure higher underpricing

when they go public in countries where the quality of earnings information is generally low? We

approach this question in an international setting for several reasons. First, as noted above,

underpricing varies dramatically across countries, and relatively little work has been done to

understand why that is the case. Second, within a single country, firms operate in the same legal

and regulatory environment, and that environment likely imposes some limit on the variability of

earnings quality across firms. Thus, it is plausible that the quality of accounting information

varies more across markets than within a single market. Third, in most cases very little

accounting information is available about a particular firm prior to its IPO. An IPO prospectus

typically offers little more than two years of pre-IPO financial information. This OLPLWV RQH¶V

ability to capture cross-sectional earnings quality differences as of the IPO date. In contrast, the

country-level earnings quality measures that we use draw upon several years of data generated by

many different firms. While these measures do not provide any information on the quality of

earnings from one IPO to another in a given country, they do capture differences in the

information environment in which firms from different countries go public. Fourth, we are

interested in whether reputable financial intermediaries, such as top-tier investment banks, play a

3
role in mitigating the information asymmetries related to earnings quality. Given the global scope

of the investment banking industry, and given the difficulties in identifying cross-sectional

earnings quality variance in a single country, the question of whether investment banks mitigate

earnings-related information asymmetries seems ideally suited to an international sample.

Despite the advantages of studying underpricing using an international sample, we must

mention one caveat associated with our research design. Underpricing differences across

countries may be influenced by omitted variables, such as differences in offering methods, which

could be correlated with our earnings quality measures. Naturally we have taken many steps to

minimize this possibility, for example by controlling for numerous country and deal

characteristics; including offering method. In addition, we appeal to evidence that IPO pricing

methods around the world are converging over time, with the U.S. bookbuilding approach

dominating in most countries. For instance, Ljungqvist et al. (2003) find that in a sample of 2,143

IPOs from 65 countries, 46.2 percent were priced using the bookbuilding method in 1994, but by

the end of their sample period (the first seven months of 1999), the fraction of new issues priced

via bookbuilding rose to 80 percent. Similarly, Jagannathan and Sherman (2006) examine the use

of auctions and bookbuilding in 46 countries and find that in all but four countries, auctions have

been abandoned entirely, and auctions are rare in the few countries that still use them. In contrast,

they find that the bookbuilding method has been gaining market share over time and has become

the dominant pricing method in most countries. So while we cannot rule out the possibility of an

omitted variables problem in our analysis, the timeliness of our sample (2000-2006) combined

with our regression control variables and robustness tests reduce this problem to the extent

possible.

Examining 7,306 IPO events, we find evidence of a statistically and economically significant

association between country-level earnings quality and IPO-firm-level underpricing. Comparing

two countries that differ in earnings quality by one standard deviation, firms going public in the

country with better earnings information experience 4.8 percentage points lower underpricing

4
(relative to a sample mean initial return of 27.5 percent). Our regression models control for many

deal-specific (e.g., offer size, industry, underwriter, and underwriting method) and country-

specific (e.g., market returns, liquidity, and IPO activity) variables that influence underpricing,

and our results are robust to the adoption of various minimum offer price screens. Furthermore,

the link between earnings quality and underpricing is driven neither by the large and relatively

transparent U.S. and U.K. markets nor by the relatively opaque market in Japan.

We also explore the influence of underwriters on underpricing and its interaction with

earnings quality. We develop a measure of underwriter quality and interact it with our earnings

quality measures. We corroborate findings from other recent studies, which suggest that since the

early 1990s IPOs underwritten by higher quality investment banks experience higher

underpricing.2 However, better underwriters mitigate the effect of poor earnings quality on

underpricing, such that firms listing in countries with relatively low earnings quality experience a

net reduction in underpricing if they are backed by higher quality underwriters.

The remainder of this paper is structured as follows. Section 2 highlights previous research on

earnings quality and IPO underpricing related to this study. Section 3 describes our sample

construction and descriptive statistics. Section 4 contains our primary results on the relations

between IPO underpricing and the quality of earnings and illustrates that many of the

conventional variables used in single-country studies of IPO underpricing also explain the

international cross-section. Section 5 summarizes and concludes.

II. Earnings quality and IPOs

A number of researchers have studied the link between accounting information disclosed in

the IPO prospectus and the market value of going-public firms. Essentially this strain of the

literature asks whether IPO firms manipulate their financial statements to obtain a higher share

price. Early papers offer modest affirmation for this hypothesis. In a study of Canadian IPOs,

2
See for example Aggarwal et al. (2002), Smart and Zutter (2003), Loughran and Ritter (2004).

5
Clarkson et al. (1992) find that some firms voluntarily disclose earnings projections in their

prospectuses, while other firms do not. Firms that choose to disclose generally report positive

earnings projections, and these projections do affect the IPO offer price. However, they also find

that the stock market is able to adjust for bias in these forecasts. Aharony et al. (1993) find weak

evidence that U.S. firms attempt to inflate earnings prior to going public. Only among very small

firms and firms with very high leverage do they find evidence of earnings manipulation around

the IPO. They also find weak evidence that high-quality underwriters and auditors limit earnings

management behavior. Friedlan (1994) reports that U.S. firms make income-increasing

discretionary accruals in interim financial statements published in the IPO prospectus, but not in

the final statements released after the IPO.

Even stronger evidence suggesting that IPO issuers manipulate the accounting numbers in

their prospectuses appears in subsequent papers. Teoh et al. (1998) provide evidence that IPO

firms have high issue-year earnings and abnormal accruals, followed by poor long-run earnings

and negative abnormal accruals. They indicate that abnormal accruals at the IPO help explain

subsequent poor stock returns. Similarly, Teoh et al. (1998) find that IPO firms that are the most

aggressive in using accruals to report cash flows in excess of earnings earn 20 percent lower stock

returns in the three years after the IPO compared to the firms reporting the most conservative

earnings figures. Firms using accruals aggressively also issue about 20 percent fewer seasoned

equity offerings. This finding leads the authors to conclude that investors naively focus on

artificially high earnings reported by some firms when they go public.3 Teoh and Wong (2002)

suggest that analysts fare no better than investors at disentangling earnings manipulation at the

3
One caveat with this study is that it uses accounting data produced after the IPO rather than before to

measure earnings manipulation. The reason provided by the authors is that pre-IPO data are not widely

available. Our study takes advantage of data from existing public companies to characterize earnings

quality in each country prior to any given IPO in that country.

6
IPO. They find that accounting accruals prediFW DQDO\VWV¶ IRUHFDVW HUURUV ERWK IRU ,32V DQG IRU

non-issuing firms, and the predictive power is greater for discretionary rather than

nondiscretionary accruals. For IPO firms, the relation between accruals and analyst forecast errors

is independent of underwriter affiliation, and predicted forecast errors are strongly tied to long-

run underperformance of IPO shares. Because accruals help predict analyst forecast errors for

firms that do not issue new equity, the authors conclude that analysts contribute to market

inefficiency, broadly speaking, because analysts are not sufficiently skeptical of earnings figures

influenced by discretionary accruals.4 Fan (2007) offers mixed support for Teoh et al. and Teoh

and Wong by reporting that discretionary accruals are indeed highest in the IPO year, consistent

with the notion that IPO issuers manage earnings. However, Fan finds no evidence of a negative

relation between IPO earnings management and subsequent stock returns. She concludes that

market participants are not fooled by the earnings management activities of IPO firms and

challenges the notion that IPO earnings management is opportunistic behavior on the part of

issuing firms.

Venkataraman et al. (2008) overturn this emerging conventional wisdom with their finding

that pre-IPO audited accruals are not opportunistically high. They examine pre-IPO financial

statements and find that pre-IPO accruals tend to be negative and less than post-IPO accruals.

They conclude that higher litigation exposure related to IPOs results in higher audit fees and more

conservative audits. In the same vein, Ball and Shivakumar (2008) find WKDW ILUPV¶ UHSRUWLQJ

practices become more conservative when they transition from private to public status through an

IPO. They examine a sample of U.K. IPOs that initially prepared financial statements as private

companies, but then later restated these statements as part of the process of going public. Because

Ball and Shivakumar rely on statements that reflect different reporting choices for the same firms

4
Two other studies that find evidence of pre-IPO earnings manipulation are Aharony et al. (2000) and

DuCharme et al. (2001).

7
in the same years, their research design controls for firm-specific factors such as growth and

profitability that may be correlated with the decision to go public. At the same time, their research

design exploits a change in the regulatory environment in which firms operate.5

Morsfield and Tan (2006) study the relation between venture capital funding and earnings

management. Building on prior studies that suggest that venture capitalists play a monitoring role

in IPO firms (e.g., Gompers and Lerner 2002; Hellman and Puri 2002), Morsfield and Tan predict

a negative relation between venture capital financing and earnings management. Controlling for

the endogeneity of venture capital funding, they find that abnormal accruals are lower for venture

capital-backed IPO firms.

All of these papers focus on the extent to which earnings manipulation leading up to the IPO

PD\ LQIOXHQFH WKH ILUP¶V VWRFN SULFH 7KH\ GR QRW ORRN DW XQGHUSULFLQJ LH WKH GLIIHUHQFH

between the IPO offer price and the market price established once trading begins), which is our

focus. However, the accounting literature does offer several insights into the influence of

accounting disclosures on IPO underpricing.

In a study of micro-cap Nasdaq IPOs, Willenborg and McKeown (2001) find that firms going

public with going-concern audit opinions are more likely to delist within two years of the IPO,

but these firms also endure less underpricing, consistent with the notion that the audit opinion

reduces information asymmetries between issuers and investors. Jog and McConomy (2003)

examine the impact of voluntary disclosure of management earnings forecasts in the IPO

prospectus on IPO valuation and performance. They find higher underpricing for IPOs that do not

include earnings forecasts, though this difference is concentrated among small firms. Schrand and

Verrecchia (2005) study the relation between underpricing and the frequency of pre-IPO

5
Lewis (2006) finds that earnings and income-increasing accruals at the IPO are more persistent when

the investment bank assisting the firm is more reputable. She also finds that investors capitalize earnings at

higher multiples when high-reputation banks are present.

8
disclosure and find lower underpricing for firms with more frequent disclosures prior to the IPO.

An exception is Internet firms, where this relation is reversed. They also find that more frequent

disclosure ameliorates adverse selection in the aftermarket, with lower bid-ask spreads and

greater depths for firms that disclosure more frequently pre-IPO. Finally, Leone et al. (2007) find

WKDW,32XQGHUSULFLQJGHFUHDVHVZKHQLVVXHUVGLVFORVHPRUHVSHFLILFLQIRUPDWLRQLQWKH³XVHVRI

SURFHHGV´ VHFWLRQ RI WKH SURVSHFWXV Collectively these papers, all of which focus on IPOs in a

single country, suggest that accounting disclosures influence underpricing.

Our study extends this analysis to a multi-country setting to determine if earnings quality at

the country level influences underpricing costs borne by firms going public in different markets.

In so doing we add to the very limited evidence on the determinants of cross-country

underpricing variation as well as contribute to another strain of the literature on the quality and

value of accounting information in different countries. For example, Defond et al. (2007) find that

earnings announcements are more informative in countries with better overall earnings quality.

Bhattacharya et al. (2003) study the extent to which cross-country variation in the quality of

accounting information influences the cost of capital and trading volume in international equity

markets. Using data from 34 countries covering 1985-1998, they measure three dimensions of

earnings opacity for each country²earnings aggressiveness, loss avoidance, and earnings

smoothing. They find robust evidence that an increase in overall earnings opacity leads to an

increase in the required return demanded by shareholders and a decrease in trading activity. In a

similar vein, Leuz et al. (2003) examine earnings management practices in 31 countries and find

that firms engage in greater earnings management in countries with weaker investor protections.6

6
Bushman and Piotroski (2006) construct earnings quality measures based upon accounting

conservatism and link those measures to cross-country variation in legal and political institutions. See also

Hung (2000) and Ball et al. (2003).

9
 These studies and others suggest that the quality of earnings information available to outside

investors influences information asymmetries in the market. Given the central role of asymmetric

information in theories of IPO underpricing, we anticipate that differences in earnings quality

across countries will influence the underpricing costs that firms going public in different

countries face. Recognizing that earnings quality is a multi-faceted concept and that no single

measure can capture all aspects of earnings quality, we employ a wide range of earnings quality

measures drawn from the extant literature and study their association with firm-level

underpricing. The measures we use are designed to capture elements of earnings quality such as

earnings smoothing, loss avoidance, earnings aggressiveness, and accounting conservatism,

among others. Below, we construct and use the earnings quality measures in Leuz et al. (2003),

Bhattacharya et al. (2003), Bushman and Piotroski (2006), and La Porta et al. (1998) to test our

earnings quality hypothesis.

III. Sample construction and descriptive statistics

Sample construction

We begin our sample construction by retrieving IPOs for all countries reported in the

Thomson Financial SDC Platinum New Issues database from 2000 through 2006. We exclude

countries with fewer than five IPOs during our sample period. Next we attempt to match each

IPO firm with Datastream to collect secondary market prices and calculate initial returns. We

identify 7,455 IPOs with valid prices and positive trading volume.7 We calculate the initial return

as the percentage price change from the offer price to the secondary market closing price (in local

7
A valid price is the first price observation in Datastream with positive trading volume that occurs

within -3 to +60 days of the SDC IPO issue date. In other words, if Datastream is reporting prices prior to -

3 or does not begin reporting prices until after +60 then the event is discarded. We require positive trading

volume to ensure that the Datastream price that we extract is a market price and not simply the IPO offer

price recorded by Datastream. Moreover, for France and Taiwan we use the tenth valid price, rather than

the first, because in these countries initial IPO prices are constrained by daily volatility limits.

10
currency). To eliminate the impact of outliers, which likely result from difficulties in matching

SDC information with valid Datastream prices, we trim our sample by removing the top and

bottom one percent based on initial return. These steps result in a final sample of 7,306 IPOs

listed in 34 countries.

Although common in the IPO literature, we do not impose a minimum offer price restriction.

For example, Ritter (1991) evaluates U.S. IPOs with a minimum offer price of $1 to mitigate the

bid-ask bounce effect. However, imposing this filter would not only greatly reduce the number of

IPOs in many countries, but it would also eliminate some countries entirely. Applying a $1

minimum offer price (converting local currency to U.S. dollars based on the exchange rate as of

the IPO date) eliminates over one-third of the sample events. Thus, the main analysis presented

here imposes no minimum offer price, but we do verify that our results are not driven by the

inclusion of IPOs with very low offer prices.8

Descriptive statistics

Figure 1 displays the average IPO underpricing and number of IPOs by year. The figure

clearly illustrates the slowdown in equity offerings following the decline in equity markets in

2000. IPO volume falls more than 50 percent from 2000 to 2001, then remains relatively flat for

2002 and 2003. The number of new issues rebounds sharply to 1,278 deals in 2004, and then falls

EDFNDELWIRUDQG&RQVLVWHQWZLWKWKH³KRWLVVXHVPDUNHW´SKHQRPHQRQ HJ5LWWHU

1984), average underpricing is positively correlated with yearly IPO volume (correlation = 0.58).

[Place Figure 1 about here]

8
Table 7 reports robustness tests using minimum offer price restrictions. In particular, the bottom 2, 5,

10, and 20 percent of offer prices are excluded from respective country-level samples. In terms of the U.S.

distribution of offer prices, these cutoffs correspond to minimums of $5, $6, $7, and $9. The main

conclusions of our analysis are the same when employing any of these restrictions.

11
 Coffee (1999, 2002) suggests that firms list abroad to bond themselves to foreign listing

standards. For example, firms listing in the U.S. subject themselves to SEC oversight, agree to

meet generally accepted accounting principles (GAAP), and face the scrutiny of financial

intermediaries involved in the security markets. While most of our IPOs originate and list in the

same country, some companies choose to list outside their home country. Most of these firms list

LQ WKH 86 RU WKH 8. %HFDXVH OLVWLQJ DEURDG FDQ ERQG PDQDJHPHQW WR WKH OLVWLQJ FRXQWU\¶V

standards, the country where the firm lists is the relevant location for this study.

Table 1 shows the IPO volume and average underpricing for each country in our sample.

Average underpricing varies widely, ranging from 57.3 percent in Japan to less than 3 percent in

Mexico. However, this variation appears to be largely unrelated to IPO volume. Not surprisingly,

the U.S. has the most IPOs in the sample, followed closely by Japan and the U.K. The aggregate

gross proceeds for the entire sample is about $573 billion of which the U.S. represents about 41

percent.

[Place Table 1 about here]

For each sample country, we calculate several earnings quality measures, described in more

GHWDLOLQWKHQH[WVHFWLRQ2QHVXFKPHDVXUHLVDFRXQWU\¶VDJJUHJDWHHDUQLQJVPDQDJHPHQWVFRUH

constructed such that a higher score implies lower quality earnings. Figure 2, groups countries

into TXDUWLOHV EDVHG RQ WKHLU DJJUHJDWH HDUQLQJV PDQDJHPHQW VFRUHV DQG UHSRUWV HDFK TXDUWLOH¶V

average underpricing and average aggregate earnings management score.

[Place Figure 2 about here]

Figure 2 offers preliminary evidence that earnings quality influences underpricing. Average

underpricing is almost 75 percent higher (or over 15 percentage points higher) in the highest

AggEM quartile compared to the lowest quartile. The simple correlation between underpricing

and aggregate earnings management scores in Figure 2 is 95 percent. Of course, many differences

in the IPO process and in the types of firms going public exist across countries, so in the next

12
section we test for a link between earnings quality and underpricing, holding constant deal-level

and other country-level characteristics.

Table 2 provides descriptive statistics for the variables used in our regression analysis,

starting with various earnings quality measures drawn from Leuz et al. (2003), Bhattacharya et al.

(2003), Bushman and Piotroski (2006), and La Porta et al. (1998). For most of these measures, we

provide up-to-date calculations (described below) for each of our sample countries and scale

these measures such that a higher value indicates lower earnings quality.9

The unit of observation in our regressions is the IPO firm, and the dependent variable is the

first-day return. The sample mean initial return equals 27.5 percent, which is roughly double the

long-run mean for U.S. underpricing. The cross-sectional standard deviation of initial returns is

52.3 percent, indicating large variations in IPO returns. Unquestionably some of this variation can

be explained by deal-specific and market-specific factors not related to earnings quality, so we

use the remaining variables listed in Table 2 to control for these effects.

Because the extent to which an IPO is underpriced may be influenced by the quality of the

underwriter, we create an underwriter market share variable similar to that proposed by

Megginson and Weiss (1991). In our analysis, the underwriter reputation measure equals the

fraction of IPO inflation-adjusted proceeds underwritten by a particular underwriter in a particular

country for our sample period. Table 2 indicates that the mean underwriter has a market share of

7.2 percent.10

In some countries, underwriters can engage in price support once trading begins.

8QGHUZULWHUV PD\ KDYH LQFHQWLYHV WR HQJDJH LQ SULFH VWDELOL]DWLRQ SDUWLFXODUO\ ZKHQ DQ ,32¶V

9
We do not recalculate the accounting conservatism measure or the accounting standards index,

relying instead upon the values published in Bushman and Piotroski (2006) and La Porta et al. (1998)

respectively.
10
Our results are broadly similar with a global market share measure.

13
market price begins to fall below the IPO offer price. If underwriters engage in price support to

limit the occurrence of negative initial returns, then the first-day returns distribution will have a

higher mean than it would have in the absence or price support. We do not have detailed data on

the regulations and practices with respect to price stabilization in all countries, so we attempt to

control for price stabilization activity in two ways. First, we construct a country-level proxy for

price stabilization activity. If price stabilization is widespread, then we expect to see an unusually

large probability mass in the distribution of first-day returns just to the right of zero and an

unusually small probability mass to the left of zero. Therefore, for each country we calculate the

difference in the number of IPOs with initial returns between zero and one percent and the

number of IPOs with initial returns between zero and negative one percent, and then divide the

difference by the total number of IPOs. The more prevalent is price stabilization in a given

market the higher should be this ratio, and the higher should be average underpricing. Table 2

reports a mean price stabilization ratio of 0.007, indicating a slightly greater incidence of small

positive initial returns than small negative returns. Our second approach to control for price

stabilization exploits the fact that underwriters typically provide price support for a very limited

time, so the effects of stabilization activities on the IPO returns distribution should diminish over

time. We calculate the IPO initial return based on the market price roughly one month (22 trading

days) after the IPO rather than on the first trading day, and we test to see if our regression results

are robust to this change.

As suggested in numerous papers, including Ritter (1984), underpricing tends to be higher

when IPO volume is high and when overall stock market returns are high. We include two

variables to control for WKHVH ³hot market´ effects. First, our IPO activity measure equals the

number of IPOs in a given country in each year divided by the total number of listed equities in

Datastream for that country in 2006. Therefore, this measure takes the same value for all IPOs

from a single country in a particular year, but within a country it varies across time, and within a

single year it varies across countries. Second, for each IPO, we calculate the return on the

14
Datastream market index in the three months leading up to the offer. Consequently, two firms

will share the same market return value only if they go public at the same time in the same

country.

Ellul and Pagano (2006) suggest that IPOs in less liquid markets will exhibit larger initial

returns. Higher underpricing compensates IPO investors for the illiquidity risk that they bear. To

control for differences in liquidity across national markets, we include a country-level stock

market turnover ratio, which is defined by Beck et al. (2000) as the ratio of total value of shares

traded to market capitalization.11 +HQFHWKHPHDVXUHFDSWXUHVDVWRFNPDUNHW¶V liquidity relative

to its size, and we expect lower initial returns in more liquid markets.

Because the state of economic development varies dramatically across our sample nations, we

include a measure of economic development in our regressions. The variable,

³XQGHUGHYHORSPHQW´ UHIOHFWV WKH H[WHQW WR ZKLFK D FRXQWU\¶V LQIUDVWUXFWXUH LV XQGHUGHYHORSHG

Underdevelopment is the sum of the rankings of infant mortality, Internet users per capita,

literacy, unemployment rate, and paved airport runways as reported by Butler and Fauver (2006).

The underdevelopment index is standardized on a 0 to 1 scale, with higher values indicating less

development. To the extent that IPO investors bear more risk when investing in underdeveloped

markets, we expect higher underpricing in countries with higher development index values.

Another country-level control variable is the Index of Economic Freedom, which is produced

by the Heritage Foundation and The Wall Street Journal. The index is an aggregate measure of

several different measures of economic freedom including: (1) the ease of starting a new

business, (2) the level of trade barriers, (3) the top marginal income tax rate, (4) government

spending as a percentage of GDP, (5) the inflation rate, (6) the ease with which foreigners can

11
Beck et al. (2000) report the ratio of total value of shares traded to market capitalization for the

period 1999-2004. Since our sample period includes 2005 and 2006, we take the average of all years

reported for a country by Beck et al. as our measure of country-level stock market turnover.

15
invest in a given country, (7) the extent of government control of the banking system, (8) legal

protection of property rights, (9) corruption, and (10) the ability of a business to hire and fire

workers without restrictions. We include the freedom index because of the literature spawned by

the work of La Porta et al. (2000) illustrating the importance of various investor protections on a

range of capital market outcomes. Unlike the La Porta et al. measures, the Index of Economic

Freedom is updated annually, so we can match it to our sample years rather than using somewhat

dated measures from older papers.12 We also include as a control variable the updated anti-

director rights index from Djankov et al. (2008) which is based on laws in place as of May 2003.

The anti-director rights index is based on a collection of legal and regulatory variables related to a

QDWLRQ¶VVWDQFHUHJDUGLQJWKHSURWHFWLRQRIVKDUHKROGHUV

Most IPO underpricing studies include measures designed to capture information

asymmetries, including the natural logarithm of the offer size, which we report in Table 2.

Because offering sizes vary widely across countries, we also construct an offer size measure that

captures the size of an IPO relative to other deals in the same country. This offer size ratio equals

the offer size divided by the mean offer size for a given country.13 We obtain broadly similar

results with both absolute and relative deal-size measures, so in Table 2 and in subsequent

regressions we simply report natural log of the CPI-adjusted total offer size for each IPO.

[Place Table 2 about here]

Bradley et al. (2004) report that IPOs with integer prices experience higher underpricing. To

H[SODLQ WKLV SDWWHUQ WKH\ SURSRVH D ³QHJRWLDWLRQ K\SRWKHVLV´ LQ ZKLFK XQGHUZULWHUV DQG LVVXHUV

bargain over finer offer price increments as the uncertainty surrounding firm value declines.
12
Moeller and Schlingemann (2005) use this index to proxy for the restrictiveness of the institutional

environment related to corporate acquisitions, and they find that in cross-border acquisitions, bidder returns

are higher when targets come from countries with greater freedom.
13
All offer sizes are measured in millions of CPI-adjusted 2006 U.S. dollars. CPI data is from the U.S.

Bureau of Labor Statistics website. SDC reports offer size in U.S. dollars.

16
Thus, for IPOs that are particularly difficult to value, and hence should have higher underpricing,

offer prices tend to fall on integers. Slightly more than 50 percent of our IPOs have an integer

price which compares to 76 percent of U.S. IPOs as reported in Bradley et al. We include in our

regression a dummy variable equal to one when the offer price is an integer.14

Sherman (2005) notes that methods for taking firms public worldwide are converging

towards the traditional U.S. bookbuilding approach, and she argues that bookbuilt offers are

associated with lower underpricing than offers conducted via auctions. Sherman argues that book

building reduces the risk faced by IPO issuers and investors, and therefore should lead to less

underpricing. However, she also notes that book building affords issuers discretion over

information expenditures, which she suggests can lead to either more or less underpricing

GHSHQGLQJ RQ WKH LVVXHU¶V SUHIHUHQFHV 5Ltter (1987) provides evidence that firm commitment

IPOs are underpriced less than best efforts IPOs. Sixty-one percent of the firms in our sample are

taken public through a firm commitment offering, while 63 percent of the deals are bookbuilt

offerings. Deals that are both firm commitment and bookbuilt represent 37.4 percent of the

sample. We include dummy variables for bookbuilt deals and for firm-commitment offerings.

Schipper and Smith (1986) and Prezas et al. (2000) provide evidence that equity carve-outs are

underpriced less than original IPOs. To capture this effect, we include a dummy variable for

carve-outs.

IV. Earnings quality

Country-level earnings quality and IPO underpricing

In this section, we ask whether earnings quality affects underpricing. We recalculate two

different sets of earnings quality measures from prior studies, and we also take two other

measures directly from published studies. For all measures, the underlying principle is that

14
In Japan all IPOs are priced on an integer. For Japanese IPOs, our integer dummy equals one if the

offer price (in yen) is perfectly divisible by 100.

17
managers can take various actions that cause the reported earnings distribution to obscure the true

underlying performance distribution. For the measures that we replicate, we use firm-level data

from Compustat Global over the years 1995 to 2005. All non-financial firms with a minimum of

three consecutive years of accounting data are included in the calculation of the earnings

measures. Each country included in the sample has a minimum of 200 firm-year observations

from Compustat Global and five IPOs with valid price and volume data. Each earnings

management measure is constructed annually over the 2000-2006 sample period using accounting

data from the prior five years.

Our first set of earnings measures come from Leuz et al. (2003). They construct four country-

level earnings management measures. The first of these, denoted EM1, is an earnings smoothing

measure equal to the median value in each country of the ratio of the firm-level standard

deviation of operating earnings divided by the standard deviation of cash flow from operations.

Their second measure, EM2, also attempts to capture earnings smoothing behavior. EM2 equals

the cross-sectional correlation in country i in year t between the change in accruals and the

change in cash flows (both scaled by assets). In order to standardize the interpretation of our

earnings quality measures, we transform our EM1 and EM2 measures by multiplying their values

by -1. Hence, higher values of EM1 and EM2 correspond to more aggressive earnings smoothing

by managers and are more likely to obscure the true variability in performance.

7KHWKLUGPHDVXUH(0LVWKHPHGLDQYDOXHLQHDFKFRXQWU\RIWKHDEVROXWHYDOXHRIILUPV¶

accruals scaled by the absolute value of cash flow from operations. A higher value of EM3

indicates greater earnings management. The final metric, EM4, measures loss avoidance

behavior. EM4 equals the ratio of the number of firms reporting small profits over the number of

ILUPVUHSRUWLQJVPDOOORVVHV,QWKLVFRQWH[W³VPDOO´PHDQVDUDWLRRIQHWLQFRPHWRDVVHWVRISOXV

or minus one percent. The intuition for this measure is that if managers manipulate earnings to

avoid showing losses, then there will be a missing probability mass in the earnings distribution

just to the left of breakeven, and a higher-than-expected frequency of firms reporting earnings

18
just above zero (see Degeorge et al. 1999). Therefore, the higher is the loss avoidance ratio, the

greater is the incidence of loss avoidance behavior in a given country and the more opaque are the

FRXQWU\¶VHDUQLQJVILJXUHV Finally, Leuz et al. (2003) calculate an overall earnings management

figure, aggregate earnings management (AggEM), for each country by ranking each country on

each of the four earnings management measures and then taking the average ranking, where

higher rankings signify more earnings management.

Bhattacharya et al. (2003), construct their own earnings quality measures that focus on three

aspects of earnings opacity. First, they define earnings aggressiveness as the tendency to

accelerate the recognition of gains and delay the recognition of losses. Their earnings

aggressiveness measure is the median for country i in year t of the ratio of total accruals divided

by lagged assets. A higher value of this ratio implies more aggressive (and more opaque)

earnings.

Bhattacharya et al. (2003) construct two other earnings opacity measures, which essentially

replicate two measures from Leuz et al. (2003). Bhattacharya et al. calculate a loss avoidance

measure for each country by taking the ratio of the number of firms with small positive earnings

divided by the number of firms with small negative earnings, and they construct an earnings

smoothing measure using the cross-sectional correlation between changes in accruals and cash

flows. Finally, Bhattacharya et al. construct a single aggregate earnings opacity measure for each

country based on a ranking methodology. Specifically, they construct deciles for each earnings

measure and then average the decile ranks across the three measures to arrive at an overall

earnings opacity ranking for each country. Countries that earn a higher average ranking have

more opaque earnings. In the tables that follow, we report regression results for all four Leuz et

al. measures as well as their aggregate earnings management score, and we report the two

³XQLTXH´PHDVXUHV (earnings aggressiveness and aggregate earnings opacity) from Bhattacharya

et al.

19
 From extant research we borrow two additional variables that capture different elements of

earnings quality. The first variable measures the extent to which firms recognize bad news

quickly and good news slowly, i.e., accounting conservatism. Bushman and Piotroski (2006)

calculate accounting conservatism measures using a sample of countries and years that

substantially overlaps our sample, so we use their estimates here rather than replicating them. The

accounting conservatism measures come from a regression of the following form:

NI E 0  E1 NEG  E 2 RET  E 3 NEG * RET  H (1)

where the dependent variable is net income before extraordinary items, NEG is a dummy variable

equal to 1 when RET is negative, and RET is the fiscal-\HDUKROGLQJSHULRGUHWXUQRQWKHILUP¶V

stock. ,Q WKLV VSHFLILFDWLRQ WKH FRHIILFLHQW ȕ3 captures the incremental speed of bad news

recognition in earnings relative to good news. ,Iȕ3 = 0, then there is no difference between the

speed of recognition of bad and good news DQG LI ȕ3 > 0, the firms recognize bad news faster

than good news. Bushman and Piotroski estimate cross-sectional regressions for each country in

WKHLUVDPSOHREWDLQLQJDVLQJOHȕ3 coefficient for each country. We borrow these estimates from

Table 2 in their paper. We multiply their estimates by -1 so that a higher value indicates less

conservative accounting.

All of the earnings quality variables discussed thus far are based on quantitative analysis

of firm-level data. Our final earnings quality measure is the more qualitative Accounting

Standards Index from La Porta et al. (1998). La Porta et al. created this index by examining

annual reports from companies and rating them based on the inclusion or omission of 90

characteristics related to the quality of corporate disclosures. We multiply this index by -1 so that

a higher value indicates weaker accounting standards. A significant disadvantage of this measure

is that it is based on data from 1990, so we include it here only as an additional robustness check.

Table 3 UHSRUWV UHJUHVVLRQ UHVXOWV IRU PRGHOV WKDW LQFOXGH WKH ³VWDQGDUG´ FRQWURO YDULDEOHV

from Table 2 as well as the earnings quality measures from Leuz et al. We estimate regressions

20
with each earnings measure separately (Models 1-4) as well as a regression that includes the

aggregate earnings management measure (Model 5). The dependent variable in the Table 3

regressions is the IPO initial return, which is calculated as the secondary market closing price

divided by the final offer price, minus one. To the extent that earnings quality is related to

information asymmetry, we expect poorer earnings quality to be associated with higher

underpricing on average.

[Place Table 3 about here]

Recall that for EM1, EM2, EM3, EM4, and the overall AggEM variable, a higher value

means more earnings management. Therefore, our earnings quality hypothesis predicts positive

coefficients for the Leuz et al. earnings quality measures. The results presented in Models 1-4

provide strong support for the earnings quality hypothesis. Each of the Leuz et al. measures enters

the regression with a positive and significant coefficient as expected. When it is common practice

in a country for managers to engage in activities to manipulate earnings, IPO underpricing is

higher. Given that all four of the individual earnings management variables link to underpricing

as expected, it is not surprising that in Model 5 the aggregate earnings management score also

indicates that poor earnings quality is associated with higher IPO underpricing.

Other results in Table 3 are broadly consistent with the extant underpricing literature. For

example, smaller IPOs and IPOs taken public after a period of high market returns have higher

underpricing. IPOs priced on integers endure higher underpricing as do firms going public in less

liquid markets. As expected, our proxy for price stabilization indicates that underpricing is higher

when price stabilization is more prevalent. We also find evidence of higher underpricing for

bookbuilt and firm commitment deals, and deals that occur following a period of low IPO

volume. The adjusted R-square values indicate that our models explain between twelve and

thirteen percent of the variation in the international underpricing cross-section.

Economically, the earnings quality effects presented in Table 3 are quite dramatic. The results

in Model 5 suggest that for a one standard deviation increase in the Leuz et al. (2003) AggEM

21
measure, underpricing increases by roughly 4.8 percentage points, or greater than one-sixth of the

sample mean initial return. As a point of reference, consider that the aggregate earnings

management measure for the Philippines is slightly more than one standard deviation above that

of the United Kingdom. Clearly, country-level earnings quality has a considerable influence on

underpricing around the world.

Table 4 repeats the cross-section analysis of IPO returns from Table 3 except that in Models 1

and 2 we replace the Leuz et al. earnings management variables with the Bhattacharya et al.

(2003) earnings aggressiveness and earnings opacity scores. Model 3 focuses on the Bushman

and Piotroski (2006) earnings conservatism variable, and Model 4 includes the La Porta et al.

accounting standards index. All of these measures are normalized such that a higher value implies

more opaque earnings, less conservative reporting practices, or weaker accounting standards.

Therefore, we expect positive signs in the regressions. Indeed, all coefficients are positive and

significant, consistent with the hypothesis that underpricing is higher in countries where investors

receive lower quality accounting information.

The Table 4 results confirm the economically significant relation between earnings quality

and IPO underpricing discussed above. Consider the accounting conservatism results reported in

Model 3. The Netherlands represents the median country in terms of accounting conservatism

(value = -0.265). Switzerland (value = -0.380) is an approximately one standard deviation

improvement from the Netherlands. The coefficient on accounting conservatism (0.652) suggests

that, all things equal, IPOs in Switzerland will be underpriced by 7.5 percentage points less than

IPOs in the Netherlands.

[Place Table 4 about here]

In Table 5 we provide a robustness check with an alternative control for price stabilization

activity by underwriters. In these regressions, we measure the IPO initial return as the percentage

difference between the offer price and the secondary market closing price 22 trading days after

the IPO. The intuition for doing this is that the effects of price stabilization dissipate over time,

22
generally within a month of the IPO, as reported in Ruud (1993) and elsewhere. Thus, if price

stabilization temporarily obscures the left tail of the IPO returns distribution, then our finding that

lower quality earnings leads to higher underpricing might be the result of greater price support in

countries with lower earnings quality. Table 5 indicates that measuring the initial return over a

longer horizon does not fundamentally change our results. All earnings quality measures have the

expected signs and are significant, and most other results from Tables 3 and 4 carry through as

well.15

[Place Table 5 about here]

The post price stabilization results reported in Table 5 continue to point to an economically

VLJQLILFDQW DVVRFLDWLRQ EHWZHHQ HDUQLQJV TXDOLW\ DQG XQGHUSULFLQJ 6RXWK .RUHD¶V HDUQLQJV

opacity (value = 5.743) is slightly above the sample mean (value = 5.477). Based on the earnings

opacity score, earnings in the United States (value = 3.295) are more transparent than those in

South Korea. The earnings opacity coefficient reported in Table 5, Model 2 suggests that, all

things equal, South Korean IPOs would reduce their underpricing by approximately 563 basis

points, on average, by improving their earnings opacity measure to that of the United States.

Together, the results in Tables 3 through 5 suggest an important link between earnings quality

and IPO underpricing.

Earnings quality and the certification effect of financial intermediaries

The idea that uncertainty, or the lack thereof, can influence underpricing is well established in

the IPO literature. One mechanism that could mitigate this uncertainty is the presence of a

reputable intermediary who, in effect, certifies the earnings of IPO firms. Carter and Manaster

15
The regression models in Tables 3 and 4 do not contain country dummies. With several right-hand-

side variables measured at the country level, some country dummies display multicollinearity with other

controls. If we introduce country dummies, the results in Tables 3 and 4 are qualitatively similar, but

slightly weaker.

23
(1990), Megginson and Weiss (1991), Barry et al. (1991) all report results consistent with a

certification effect (i.e., lower underpricing) when firms go public with the assistance of reputable

underwriters or venture capital investors.16 However, most recent underpricing studies find a

positive relation between underwriter quality and initial returns. Why IPOs underwritten by more

prestigious investment banks are underpriced more remains an unanswered question, but our

results indicate that this pattern continues for recent years and across the globe.

In spite of the positive coefficient for underwriter reputation, underwriters can still play a role

in reducing underpricing in countries with high levels of information asymmetries. In Table 6 we

include an interaction between our underwriter reputation measure and each of the earnings

quality measures. For example, Table 6 Model 1 includes an interaction term between the

underwriter quality and aggregate earnings management measure. If higher quality underwriters

certify the earnings of IPO firms and thereby reduce the uncertainty faced by investors, then we

expect the interaction terms to have the opposite sign of the relevant earnings quality measure. In

all four regression specifications in Table 6, the coefficient on the interaction between

underwriter reputation and earnings quality is significant and takes the opposite sign of the

earnings quality coefficient.

[Place Table 6 about here]

The coefficients on the interaction terms indicate that IPO issuers benefit more from

XQGHUZULWHU TXDOLW\ WKH OHVV WUDQVSDUHQW D FRXQWU\¶V HDUQLQJV 7R LOOXVWUDWH WKH HFRQRPLF

significance of this result, consider an issuer in India with an average earnings opacity score of

8.0. Suppose one firm in India goes public with the assistance of an underwriter with the sample

median reputation (i.e., market share) of 0.021, and another firm uses an underwriter with a

reputation at the 75th percentile, 0.081. The coefficient on the interaction term in Model 2 of

16
Due to missing data, reported results do not control for venture capital backing. Unreported tests

indicate that all results are robust to controlling for venture capital backing where available.

24
Table 6 is -0.259, and the coefficient on the underwriter reputation variable is 1.763. Moving

from the median to the 75th percentile in terms of underwriter quality has a significant net effect

on underpricing for Indian IPOs. Underpricing increases through the underwriter reputation

coefficient by 0.06 times 1.763, but underpricing falls through the interaction term by 0.06 times

the product of -0.259 and 8.0, thus the net effect is an underpricing reduction of 185 basis points.

We obtain similar results when examining the interaction between the other proxies for earnings

quality and underwriter reputation. These results are consistent with underwriter reputation acting

as certification for new issues and are particularly important in countries with lower earnings

quality.

Table 7 provides additional robustness checks. In Models 1-4 we impose increasingly

stringent restrictions on our country-level sample by imposing a minimum offer price cutoff. In

particular, the bottom 2, 5, 10, and 20 percent of offer prices are excluded from respective

country-level samples. In terms of the U.S. distribution of offer prices, these cutoffs correspond to

minimums of $5, $6, $7, and $9. Increasing the minimum offer price reduces the odds of finding

spurious results driven by market microstructure effects. In this table, we report only one earnings

quality measure, the aggregate earnings management score, but we obtain similar results with the

other earnings quality measures. In all cases, the results indicate that an economically and

statistically significant increase in underpricing occurs when earnings quality deteriorates. As

before, high-quality underwriters mitigate this effect. In models 5-7, we exclude each of the three

largest IPO markets in our sample, the U.S., the U.K, and Japan. We do this simply to illustrate

that the earnings quality results are not driven exclusively by these markets. Excluding any of

these three countries, lower earnings quality is still associated with higher underpricing.

Similarly, the underwriter certification effect persists when we impose stringent minimum offer

price restrictions on the sample, or when we exclude the U.S., the U.K., or Japan.

[Place Table 7 about here]

25
 V. Conclusion

In this paper we examine IPO underpricing across many different countries. Many of the

relations documented previously in single-country studies hold up in an international setting.

However, our primary contribution is not simply to verify the robustness of established effects

within the international cross-section, but to study how country-level differences in earnings

informativeness influence underpricing.

Using a wide range of earnings quality measures, we find higher underpricing in countries

with lower earnings quality even after controlling for many country- and deal-specific

characteristics. This evidence is consistent with asymmetric information explanations for

underpricing. Just as other researchers have found that poor accounting information can lead to a

higher cost of capital, our evidence suggests that the cost of going public rises when investors

have greater difficulties interpreting financial information. However, financial intermediaries

such as investment banks play a role in mitigating the effects of low earnings quality on

underpricing. These results are robust to controlling for deal- and macroeconomic-specific

characteristics.

26
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Teoh, S. H., T. J. Wong, and G. R. Rao. 1998. Are accruals during initial public offerings

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Venkataraman, R., J. P. Weber, and M. Willenborg. 2008. Litigation risk, audit quality, and audit

fees: Evidence from initial public offerings. The Accounting Review 83 (September): 1315-

1345.

Welch, I. 1989. Seasoned offerings, imitation costs, and the underpricing of initial public

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Willenborg, M., and J. C. Mckeown. 2001. Going-concern initial public offerings. Journal of

Accounting and Economics 30 (December): 279-313.

32
 35.00% 1600

1400
30.00%

1200
25.00%

1000
Average Underpricing

20.00%

New Issues
800

15.00%

600

10.00%
400

5.00%
200

0.00% 0
2000 2001 2002 2003 2004 2005 2006

Average Underpricing New Issues

Fig. 1. Average underpricing and number of IPOs by year. Bars show average underpricing by year and
correspond to the left axis. Line points show the number of new issues by year and correspond to the right
axis. Underpricing is the first-day secondary market closing price divided by the final offer price, minus
one.

33
 40.00% 30.00

35.00%
25.00

30.00%

Average Aggregate Earnings Management

20.00
25.00%
Average Underpricing

20.00% 15.00

15.00%
10.00

10.00%

5.00
5.00%

0.00% 0.00
Lowest earnings Highest earnings
quality quartile quality quartile

Aggregate Earnings Quality Quartile

Average Underpricing Ave. Aggregate Earnings Management Score

Fig. 2. Underpricing and aggregate earnings management (AggEM) of IPOs by AggEM quartiles. Sample
countries are separated into quartiles based on their average AggEM score over the 2000-2006 sample
period. Bars show average underpricing by quartile and correspond to the left axis. Underpricing is the
first-day secondary market closing price divided by the final offer price, minus one. Line points show the
average AggEM score by quartile and correspond to the right axis. AggEM is the average country i ranking
across the following four earnings management measures: EM1, EM2, EM3, and EM4. EM1 is the median
ratio in country i of the firm-level standard deviations of operating earnings over the cash flow from
operations (both scaled by lagged total assets), multiplied by -1. EM2 is the cross-sectional correlation in
country i between the change in accruals and change in cash flows from operations (both scaled by lagged
total assets), multiplied by -1. EM3 is the median ratio in country i of the absolute value of accruals over
the absolute value of cash flow from operations. EM4 is the ratio in country i of the number of firms
reporting small profits over the number of firms reporting small losses. A small profit (loss) is defined as a
value of net earnings scaled by lagged total assets in the range [0, 0.01] ([-0.01, 0)).

34
Table 1
Country-level Descriptive Statistics
Country N Average Underpricing Aggregate Gross Proceeds (US$ MM)
Australia 711 19.96% 15,575.33
Austria 25 14.31% 4,194.38
Belgium 24 8.11% 3,669.78
Brazil 28 8.96% 5,735.15
Canada 21 37.03% 2,462.26
Denmark 15 23.18% 1,409.35
Finland 21 18.94% 1,904.69
France 282 12.63% 21,473.64
Germany 223 29.96% 25,350.67
Greece 49 28.02% 1,370.63
Hong Kong 521 16.10% 43,397.99
India 97 38.73% 7,558.13
Indonesia 53 38.89% 1,549.59
Italy 99 9.62% 12,319.03
Japan 1,092 57.29% 51,969.59
Malaysia 331 35.04% 2,816.09
Mexico 5 2.53% 419.23
Netherlands 12 13.49% 3,691.84
New Zealand 35 15.03% 967.92
Norway 60 4.18% 7,628.94
Philippines 23 14.08% 674.42
Poland 23 50.97% 1,805.38
Portugal 8 10.65% 1,676.34
Singapore 360 20.37% 7,295.99
South Africa 5 16.85% 221.70
South Korea 327 49.08% 13,619.99
Spain 20 7.95% 6,209.96
Sweden 42 6.22% 7,882.64
Switzerland 43 14.86% 8,544.51
Taiwan 431 17.90% 6,626.98
Thailand 153 18.35% 5,016.80
Turkey 5 19.51% 746.84
United Kingdom 1,034 17.70% 63,976.36
United States 1,128 24.60% 233,222.79

Full Sample 7,306 27.53% 572,984.96

This table presents country-level descriptive statistics for the entire sample of 7,306 IPOs. N is the number
of sample IPOs listing in the country over the 2000-2006 sample period. Underpricing is the first-day
secondary market closing price divided by the final offer price, minus one. Aggregate gross proceeds is the
sum of CPI-adjusted offer value in 2006 U.S. dollars for the country of listing.

35
Table 2
IPO Sample Descriptive Statistics
Variable N Mean Std Dev Minimum Maximum
EM1 7,306 -0.486 0.135 -0.894 -0.254
EM2 7,306 0.829 0.235 0.074 1.000
EM3 7,306 0.612 0.135 0.348 0.998
EM4 7,306 2.771 1.230 0.000 11.000
Aggregate EM 7,306 17.052 8.022 4.500 32.250
Earnings aggressiveness 7,306 -0.039 0.012 -0.086 0.023
Earnings opacity 7,306 5.477 1.392 2.533 8.800
Accounting conservatism 7,283 -0.257 0.118 -0.618 0.145
Accounting standards index 7,283 -69.535 8.538 -83.000 0.000
Initial return 7,306 0.275 0.523 -0.527 3.885
Underwriter reputation 6,834 0.072 0.111 0.000 0.766
Price stabilization 7,306 0.007 0.023 -0.125 0.200
IPO activity 7,306 0.045 0.027 0.000 0.134
Market return 7,306 0.021 0.093 -0.412 0.656
Stock market turnover ratio 7,306 1.082 0.648 0.173 2.946
Underdevelopment 7,306 0.285 0.092 0.200 0.680
Index of economic freedom 7,306 73.875 8.961 45.748 91.367
Antidirector rights index 7,306 3.859 0.888 2.000 5.000
Offer size 7,294 78.556 301.247 0.100 10568.200
Integer offer price 7,306 0.503 0.500 0.000 1.000
Bookbuilt 7,169 0.629 0.483 0.000 1.000
Firm commitment 7,256 0.608 0.488 0.000 1.000
Equity carve-out 7,241 0.038 0.190 0.000 1.000
This table presents descriptive statistics for the entire sample of 7,306 IPOs. EM1 is the median ratio in
country i of the firm-level standard deviations of operating earnings over the cash flow from operations
(both scaled by lagged total assets), multiplied by -1. EM2 is the cross-sectional correlation in country i
between the change in accruals and change in cash flows from operations (both scaled by lagged total
assets), multiplied by -1. EM3 is the median ratio in country i of the absolute value of accruals over the
absolute value of cash flow from operations. EM4 is the ratio in country i of the number of firms reporting
small profits over the number of firms reporting small losses. A small profit (loss) is defined as a value of
net earnings scaled by lagged total assets in the range [0, 0.01] ([-0.01, 0)). AggEM is the average country i
ranking across the following four earnings management measures: EM1, EM2, EM3, and EM4. Earnings
aggressiveness is the median ratio in country i of total accruals over the lagged total assets. Earnings
opacity is the average country i decile ranking across the following three earnings management measures:
EM2, EM4, and earnings aggressiveness. $FFRXQWLQJFRQVHUYDWLVPPHDVXUHVWKH³DV\PPHWULFWLPHOLQHVVRI
HDUQLQJV´ DV UHSRUWHG E\ %XVKPDQ DQG 3LRWURVNL (2006). Accounting conservatism reported by Bushman
and Piotroski is multiplied by - $FFRXQWLQJ VWDQGDUGV LQGH[ LV ³FUHDWHG E\ H[DPLQLQJ DQG UDWLQJ
FRPSDQLHV¶DQQXDOUHSRUWVRQWKHLULQFOXVLRQRURPLVVLRQRILWHPV´DVUHSRUWHGLQ/D3RUWD et al.
(1998). Accounting standards index reported by La Porta, et al. is multiplied by -1. Initial return is the
secondary market closing price divided by the final offer price, minus one. Underwriter reputation is the
country of listing Megginson-Weiss underwriter market share measure, which is the fraction of total CPI-
adjusted offer value underwritten by a given underwriter for the sample. Price stabilization is the difference
in the number of IPOs with small positive first day returns (greater than zero and less than or equal to one
percent) and the number of IPOs with small negative first day returns (less than zero and greater than or
equal to negative one percent) divided by the total number of IPOs issued in the country of listing. IPO
activity is the ratio of the total number of IPOs in the issue year divided by the number of Datastream listed
equities for the country of listing as of 2006. Market return is the return on the Datastream index for the
country of listing over the three months preceding the offering. Stock market turnover ratio equals the ratio
of the total value of shares traded to aggregate market capitalization and reported in Beck et al. (2000).
Underdevelopment is the sum of the rankings of infant mortality, internet users per population, literacy,
unemployment rate, and paved airport runways as reported by Butler and Fauver (2006). Index of economic
freedom is a product of The Heritage Foundation and The Wall Street Journal and is an aggregate measure
covering the following ten freedoms: business, trade, monetary, freedom from government, fiscal, property

36
rights, investment, financial, freedom from corruption, and labor. Antidirector rights index measures
shareholder rights by considering the following issues: (1) vote by mail, (2) shares not blocked or deposited
prior to shareholder meetings, (3) cumulative voting in director elections, (4) oppressed minority
mechanisms, (5) pre-emptive rights to new issues, and (6) minimum capital requirements and is reported in
Djankov et al. (2008). Offer size is the CPI-adjusted offer value in millions of U.S. dollars. Indicator
variables are set equal to one for integer offer price, bookbuilt, firm commitment, and equity carve-out
deals.

37
Table 3
Underpricing Regressions on Earnings Quality
Model 1 Model 2 Model 3 Model 4 Model 5
Intercept 0.905*** 0.425*** 0.495*** 0.563*** 0.501***
EM1 0.526***
EM2 0.166***
EM3 0.272***
EM4 0.022***
Aggregate EM 0.006***
Underwriter reputation 0.200*** 0.243*** 0.240*** 0.254*** 0.224***
Price stabilization 1.464*** 1.422*** 1.577*** 1.291*** 1.560***
IPO activity -1.259*** -0.500 -0.503 -0.221 -0.859**
Market return 1.161*** 1.132*** 1.147*** 1.135*** 1.152***
Stock market turnover ratio -0.028** -0.001 -0.013 -0.021 -0.006
Underdevelopment -0.754*** -0.602*** -0.711*** -0.605*** -0.672***
Index of economic freedom -0.004*** -0.004*** -0.005*** -0.003*** -0.004***
Antidirector rights index 0.073*** 0.072*** 0.072*** 0.048*** 0.070***
Offer size -0.050*** -0.056*** -0.053*** -0.054*** -0.052***
Integer offer price 0.149*** 0.154*** 0.161*** 0.154*** 0.154***
Bookbuilt 0.029* 0.070*** 0.060*** 0.031* 0.050***
Firm commitment 0.113*** 0.128*** 0.132*** 0.135*** 0.122***
Equity carve-out -0.019 -0.013 -0.014 -0.015 -0.017

Adjusted R-square 13.02% 12.52% 12.36% 12.35% 12.56%

Number of observations 6,650 6,650 6,650 6,650 6,650
This table presents OLS regressions of IPO underpricing on country-level earnings quality measures. The
dependent variable is the IPO initial return, which is the secondary market closing price divided by the final
offer price, minus one. EM1 is the median ratio in country i of the firm-level standard deviations of
operating earnings over the cash flow from operations (both scaled by lagged total assets), multiplied by -1.
EM2 is the cross-sectional correlation in country i between the change in accruals and change in cash flows
from operations (both scaled by lagged total assets), multiplied by -1. EM3 is the median ratio in country i
of the absolute value of accruals over the absolute value of cash flow from operations. EM4 is the ratio in
country i of the number of firms reporting small profits over the number of firms reporting small losses. A
small profit (loss) is defined as a value of net earnings scaled by lagged total assets in the range [0, 0.01] ([-
0.01, 0)). AggEM is the average country i ranking across the following four earnings management
measures: EM1, EM2, EM3, and EM4. Underwriter reputation is the country of listing Megginson-Weiss
underwriter market share measure, which is the fraction of total CPI-adjusted offer value underwritten by a
given underwriter for the sample. Price stabilization is the difference in the number of IPOs with small
positive first day returns (greater than zero and less than or equal to one percent) and the number of IPOs
with small negative first day returns (less than zero and greater than or equal to negative one percent)
divided by the total number of IPOs issued in the country of listing. IPO activity is the ratio of the total
number of IPOs in the issue year divided by the number of Datastream listed equities for the country of
listing as of 2006. Market return is the return on the Datastream index for the country of listing over the
three months preceding the offering. Stock market turnover ratio equals the ratio of the total value of shares
traded to aggregate market capitalization and reported in Beck et al. (2000). Underdevelopment is the sum
of the rankings of infant mortality, internet users per population, literacy, unemployment rate, and paved
airport runways as reported by Butler and Fauver (2006). Index of economic freedom is a product of The
Heritage Foundation and The Wall Street Journal and is an aggregate measure covering the following ten
freedoms: business, trade, monetary, freedom from government, fiscal, property rights, investment,
financial, freedom from corruption, and labor. Antidirector rights index measures shareholder rights by
considering the following issues: (1) vote by mail, (2) shares not blocked or deposited prior to shareholder
meetings, (3) cumulative voting in director elections, (4) oppressed minority mechanisms, (5) pre-emptive
rights to new issues, and (6) minimum capital requirements and is reported in Djankov et al. (2008). Offer
size is the natural log of the CPI-adjusted offer value in millions of U.S. dollars. Indicator variables are set
equal to one for integer offer price, bookbuilt, firm commitment, and equity carve-out deals. Regressions

Page 38
include IPO year and industry dummies. Industry classifications reflect those reported by Dyck and
Zingales (2004). Respectively, ***, **, and * denote significance of the coefficient at the 1, 5, and 10
percent level.

Page 39
Table 4
Underpricing Regressions on Alternative Earnings Quality Measures

Model 1 Model 2 Model 3 Model 4

Intercept 0.844*** 0.474*** 0.614*** 1.277***
Earnings aggressiveness 4.018***
Earnings opacity 0.029***
Accounting conservatism 0.652***
Accounting standards index 0.012***
Underwriter reputation 0.251*** 0.234*** 0.180*** 0.221***
Price stabilization 1.673*** 1.449*** 0.382 1.289***
IPO activity 0.062 -0.682** -0.797** -0.398
Market return 1.142*** 1.138*** 1.162*** 1.165***
Stock market turnover ratio -0.021 -0.006 -0.043*** -0.030**
Underdevelopment -0.681*** -0.608*** -0.397*** -0.883***
Index of economic freedom -0.005*** -0.004*** 0.001 -0.002**
Antidirector rights index 0.054*** 0.054*** 0.019* 0.094***
Offer size -0.052*** -0.053*** -0.053*** -0.055***
Integer offer price 0.162*** 0.153*** 0.150*** 0.140***
Bookbuilt 0.057*** 0.046*** 0.044*** 0.032*
Firm commitment 0.095*** 0.115*** 0.105*** 0.139***
Equity carve-out -0.013 -0.018 -0.013 -0.011

Adjusted R-square 12.63% 12.47% 13.22% 13.28%

Number of observations 6,650 6,650 6,632 6,585
This table presents OLS regressions of IPO underpricing on country-level earnings quality measures. The
dependent variable is the IPO initial return, which is the secondary market closing price divided by the final
offer price, minus one. Earnings aggressiveness is the median ratio in country i of total accruals over the
lagged total assets. Earnings opacity is the average country i decile ranking across the following three
earnings management measures: EM2, EM4, and earnings aggressiveness. EM2 is the cross-sectional
correlation in country i between the change in accruals and change in cash flows from operations (both
scaled by lagged total assets), multiplied by -1. EM4 is the ratio in country i of the number of firms
reporting small profits over the number of firms reporting small losses. A small profit (loss) is defined as a
value of net earnings scaled by lagged total assets in the range [0, 0.01] ([-0.01, 0)). Accounting
FRQVHUYDWLVP PHDVXUHV WKH ³DV\PPHWULF WLPHOLQHVV RI HDUQLQJV´ DV UHSRUWHG E\ %XVKPDQ DQG 3LRWURVNL
(2006). Accounting conservatism reported by Bushman and Piotroski is multiplied by -1. Accounting
standards indH[LV³FUHDWHGE\H[DPLQLQJDQGUDWLQJFRPSDQLHV¶DQQXDOUHSRUWVRQWKHLULQFOXVLRQRU
RPLVVLRQ RI  LWHPV´ DV UHSRUWHG LQ /D 3RUWD et al. (1998). Accounting standards index reported by La
Porta, et al. is multiplied by -1. Underwriter reputation is the country of listing Megginson-Weiss
underwriter market share measure, which is the fraction of total CPI-adjusted offer value underwritten by a
given underwriter for the sample. Price stabilization is the difference in the number of IPOs with small
positive first day returns (greater than zero and less than or equal to one percent) and the number of IPOs
with small negative first day returns (less than zero and greater than or equal to negative one percent)
divided by the total number of IPOs issued in the country of listing. IPO activity is the ratio of the total
number of IPOs in the issue year divided by the number of Datastream listed equities for the country of
listing as of 2006. Market return is the return on the Datastream index for the country of listing over the
three months preceding the offering. Stock market turnover ratio equals the ratio of the total value of shares
traded to aggregate market capitalization and reported in Beck et al. (2000). Underdevelopment is the sum
of the rankings of infant mortality, internet users per population, literacy, unemployment rate, and paved
airport runways as reported by Butler and Fauver (2006). Index of economic freedom is a product of The
Heritage Foundation and The Wall Street Journal and is an aggregate measure covering the following ten
freedoms: business, trade, monetary, freedom from government, fiscal, property rights, investment,

Page 40
financial, freedom from corruption, and labor. Antidirector rights index measures shareholder rights by
considering the following issues: (1) vote by mail, (2) shares not blocked or deposited prior to shareholder
meetings, (3) cumulative voting in director elections, (4) oppressed minority mechanisms, (5) pre-emptive
rights to new issues, and (6) minimum capital requirements and is reported in Djankov et al. (2008). Offer
size is the natural log of the CPI-adjusted offer value in millions of U.S. dollars. Indicator variables are set
equal to one for integer offer price, bookbuilt, firm commitment, and equity carve-out deals. Regressions
include IPO year and industry dummies. Industry classifications reflect those reported by Dyck and
Zingales (2004). Respectively, ***, **, and * denote significance of the coefficient at the 1, 5, and 10
percent level.

Page 41
Table 5
Underpricing Regressions on Earnings Quality Following Price Stabilization

Model 1 Model 2 Model 3 Model 4

Intercept 0.484*** 0.455*** 0.556*** 1.260***
Aggregate EM 0.004***
Earnings opacity 0.023**
Accounting conservatism 0.624***
Accounting standards index 0.013***
Underwriter reputation 0.328*** 0.334*** 0.287*** 0.313***
IPO activity -1.060** -0.945* -0.925** -0.777*
Market return 1.297*** 1.286*** 1.298*** 1.303***
Stock market turnover ratio -0.017 -0.016 -0.045** -0.036*
Underdevelopment -0.497*** -0.457*** -0.319*** -0.792***
Index of economic freedom -0.003** -0.002* 0.002 0.000
Antidirector rights index 0.045*** 0.034** 0.013 0.078***
Offer size -0.055*** -0.055*** -0.057*** -0.058***
Integer offer price 0.189*** 0.188*** 0.183*** 0.171***
Bookbuilt 0.104*** 0.101*** 0.092*** 0.086***
Firm commitment 0.106*** 0.099*** 0.082*** 0.118***
Equity carve-out -0.055 -0.057 -0.051 -0.050

Adjusted R-square 7.43% 7.42% 7.87% 7.97%

Number of observations 6,617 6,617 6,600 6,553
This table presents OLS regressions of IPO underpricing on country-level earnings quality measures. The
dependent variable is the post-price stabilization IPO initial return, which is the 22nd secondary market
closing price divided by the final offer price, minus one. AggEM is the average country i ranking across the
following four earnings management measures: EM1, EM2, EM3, and EM4. EM1 is the median ratio in
country i of the firm-level standard deviations of operating earnings over the cash flow from operations
(both scaled by lagged total assets), multiplied by -1. EM2 is the cross-sectional correlation in country i
between the change in accruals and change in cash flows from operations (both scaled by lagged total
assets), multiplied by -1. EM3 is the median ratio in country i of the absolute value of accruals over the
absolute value of cash flow from operations. EM4 is the ratio in country i of the number of firms reporting
small profits over the number of firms reporting small losses. A small profit (loss) is defined as a value of
net earnings scaled by lagged total assets in the range [0, 0.01] ([-0.01, 0)). Earnings opacity is the average
country i decile ranking across the following three earnings management measures: EM2, EM4, and
earnings aggressiveness. Earnings aggressiveness is the median ratio in country i of total accruals over the
lagged total assets. $FFRXQWLQJFRQVHUYDWLVPPHDVXUHVWKH³DV\PPHWULFWLPHOLQHVVRIHDUQLQJV´DVUHSRUWed
by Bushman and Piotroski (2006). Accounting conservatism reported by Bushman and Piotroski is
multiplied by -1. $FFRXQWLQJVWDQGDUGVLQGH[LV³FUHDWHGE\H[DPLQLQJDQGUDWLQJFRPSDQLHV¶DQQXDO
UHSRUWV RQ WKHLU LQFOXVLRQ RU RPLVVLRQ RI  LWHPV´ DV reported in La Porta et al. (1998). Accounting
standards index reported by La Porta, et al. is multiplied by -1. Underwriter reputation is the country of
listing Megginson-Weiss underwriter market share measure, which is the fraction of total CPI-adjusted
offer value underwritten by a given underwriter for the sample. Price stabilization is the difference in the
number of IPOs with small positive first day returns (greater than zero and less than or equal to one
percent) and the number of IPOs with small negative first day returns (less than zero and greater than or
equal to negative one percent) divided by the total number of IPOs issued in the country of listing. IPO
activity is the ratio of the total number of IPOs in the issue year divided by the number of Datastream listed
equities for the country of listing as of 2006. Market return is the return on the Datastream index for the
country of listing over the three months preceding the offering. Stock market turnover ratio equals the ratio
of the total value of shares traded to aggregate market capitalization and reported in Beck et al. (2000).

Page 42
Underdevelopment is the sum of the rankings of infant mortality, internet users per population, literacy,
unemployment rate, and paved airport runways as reported by Butler and Fauver (2006). Index of economic
freedom is a product of The Heritage Foundation and The Wall Street Journal and is an aggregate measure
covering the following ten freedoms: business, trade, monetary, freedom from government, fiscal, property
rights, investment, financial, freedom from corruption, and labor. Antidirector rights index measures
shareholder rights by considering the following issues: (1) vote by mail, (2) shares not blocked or deposited
prior to shareholder meetings, (3) cumulative voting in director elections, (4) oppressed minority
mechanisms, (5) pre-emptive rights to new issues, and (6) minimum capital requirements and is reported in
Djankov et al. (2008). Offer size is the natural log of the CPI-adjusted offer value in millions of U.S.
dollars. Indicator variables are set equal to one for integer offer price, bookbuilt, firm commitment, and
equity carve-out deals. Regressions include IPO year and industry dummies. Industry classifications reflect
those reported by Dyck and Zingales (2004). Respectively, ***, **, and * denote significance of the
coefficient at the 1, 5, and 10 percent level.

Page 43
Table 6
Underpricing Regressions on Earnings Quality with Underwriter Certification

Model 1 Model 2 Model 3 Model 4

Intercept 0.465*** 0.398*** 0.646*** 1.507***
Aggregate EM 0.010***
Earnings opacity 0.049***
Accounting conservatism 0.821***
Accounting standards index 0.016***
Underwriter reputation 1.278*** 1.763*** -0.161 -2.117***
Underwriter reputation * earnings measure -0.054*** -0.259*** -1.580*** -0.034***
Price stabilization 1.744*** 1.541*** 0.439 1.229***
IPO activity -0.939*** -0.754** -0.794** -0.466
Market return 1.146*** 1.136*** 1.163*** 1.163***
Stock market turnover ratio -0.002 -0.003 -0.047*** -0.028**
Underdevelopment -0.858*** -0.715*** -0.411*** -0.941***
Index of economic freedom -0.004*** -0.004*** 0.001 -0.002*
Antidirector rights index 0.083*** 0.065*** 0.020* 0.105***
Offer size -0.055*** -0.055*** -0.054*** -0.055***
Integer offer price 0.151*** 0.153*** 0.147*** 0.136***
Bookbuilt 0.053*** 0.051*** 0.045*** 0.036**
Firm commitment 0.127*** 0.121*** 0.109*** 0.138***
Equity carve-out -0.023 -0.024 -0.015 -0.012

Adjusted R-square 13.16% 12.94% 13.41% 13.46%

Number of observations 6,650 6,650 6,632 6,585
This table presents OLS regressions of IPO underpricing on country-level earnings quality measures and
the interaction of underwriter reputation and earnings quality. The dependent variable is the IPO initial
return, which is the secondary market closing price divided by the final offer price, minus one. AggEM is
the average country i ranking across the following four earnings management measures: EM1, EM2, EM3,
and EM4. EM1 is the median ratio in country i of the firm-level standard deviations of operating earnings
over the cash flow from operations (both scaled by lagged total assets), multiplied by -1. EM2 is the cross-
sectional correlation in country i between the change in accruals and change in cash flows from operations
(both scaled by lagged total assets), multiplied by -1. EM3 is the median ratio in country i of the absolute
value of accruals over the absolute value of cash flow from operations. EM4 is the ratio in country i of the
number of firms reporting small profits over the number of firms reporting small losses. A small profit
(loss) is defined as a value of net earnings scaled by lagged total assets in the range [0, 0.01] ([-0.01, 0)).
Earnings opacity is the average country i decile ranking across the following three earnings management
measures: EM2, EM4, and earnings aggressiveness. Earnings aggressiveness is the median ratio in country
i of total accruals over the lagged total assets. $FFRXQWLQJ FRQVHUYDWLVP PHDVXUHV WKH ³DV\PPHWULF
WLPHOLQHVVRIHDUQLQJV´DVUHSRUWHGE\%XVKPDQDQG3LRWURVNL(2006). Accounting conservatism reported by
Bushman and Piotroski is multiplied by -1. $FFRXQWLQJVWDQGDUGVLQGH[LV³FUHDWHGE\H[DPLQLQJDQGUDWLQJ
FRPSDQLHV¶DQQXDOUHSRUWVRQWKHLULQFOXVLRQRURPLVVLRQRILWHPV´DVUHSRUWHGLQ/D3RUWD et al.
(1998). Accounting standards index reported by La Porta, et al. is multiplied by -1. Underwriter reputation
is the country of listing Megginson-Weiss underwriter market share measure, which is the fraction of total
CPI-adjusted offer value underwritten by a given underwriter for the sample. Price stabilization is the
difference in the number of IPOs with small positive first day returns (greater than zero and less than or
equal to one percent) and the number of IPOs with small negative first day returns (less than zero and
greater than or equal to negative one percent) divided by the total number of IPOs issued in the country of
listing. IPO activity is the ratio of the total number of IPOs in the issue year divided by the number of
Datastream listed equities for the country of listing as of 2006. Market return is the return on the
Datastream index for the country of listing over the three months preceding the offering. Stock market
turnover ratio equals the ratio of the total value of shares traded to aggregate market capitalization and

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reported in Beck et al. (2000). Underdevelopment is the sum of the rankings of infant mortality, internet
users per population, literacy, unemployment rate, and paved airport runways as reported by Butler and
Fauver (2006). Index of economic freedom is a product of The Heritage Foundation and The Wall Street
Journal and is an aggregate measure covering the following ten freedoms: business, trade, monetary,
freedom from government, fiscal, property rights, investment, financial, freedom from corruption, and
labor. Antidirector rights index measures shareholder rights by considering the following issues: (1) vote by
mail, (2) shares not blocked or deposited prior to shareholder meetings, (3) cumulative voting in director
elections, (4) oppressed minority mechanisms, (5) pre-emptive rights to new issues, and (6) minimum
capital requirements and is reported in Djankov et al. (2008). Offer size is the natural log of the CPI-
adjusted offer value in millions of U.S. dollars. Indicator variables are set equal to one for integer offer
price, bookbuilt, firm commitment, and equity carve-out deals. Regressions include IPO year and industry
dummies. Industry classifications reflect those reported by Dyck and Zingales (2004). Respectively, ***,
**, and * denote significance of the coefficient at the 1, 5, and 10 percent level.

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Table 7
Underpricing Regressions on Earnings Quality Robustness

Eliminate bottom 2% Eliminate bottom 5% Eliminate bottom 10% Eliminate bottom 20% Excluding U.S. Excluding U.K. Excluding Japan
Intercept 0.462*** 0.483*** 0.514*** 0.580*** 0.301*** 0.448*** 0.329***
Aggregate EM 0.010*** 0.011*** 0.011*** 0.010*** 0.011*** 0.009*** 0.002*
Underwriter reputation 1.175*** 1.126*** 0.972*** 0.924*** 0.750*** 1.154*** 0.781***
Underwriter reputation * Aggregate EM -0.050*** -0.049*** -0.043*** -0.039*** -0.030*** -0.051*** -0.032***
Price stabilization 0.299 0.295 0.255 -0.034 0.283 -0.011 0.618***
IPO activity -1.390*** -1.556*** -1.796*** -2.030*** -1.267*** -1.292*** -0.830***
Market return 1.183*** 1.176*** 1.200*** 1.260*** 1.120*** 1.180*** 1.045***
Stock market turnover ratio -0.005 -0.008 -0.016 -0.027 -0.005 0.012 0.096***
Underdevelopment -0.836*** -0.844*** -0.856*** -0.845*** -0.778*** -0.965*** -0.059
Index of economic freedom -0.003*** -0.003*** -0.003*** -0.002* -0.003*** -0.004*** -0.003***
Antidirector rights index 0.064*** 0.059*** 0.052*** 0.032** 0.067*** 0.100*** 0.069***
Offer size -0.055*** -0.056*** -0.056*** -0.060*** -0.062*** -0.050*** -0.030***
Integer offer price 0.148*** 0.151*** 0.150*** 0.149*** 0.171*** 0.152*** -0.008
Bookbuilt 0.058*** 0.061*** 0.063*** 0.077*** 0.077*** 0.081*** -0.017
Firm commitment 0.140*** 0.143*** 0.156*** 0.174*** 0.090*** 0.114*** 0.056***
Equity carve-out -0.030 -0.032 -0.029 -0.035 -0.050 -0.034 -0.006

Adjusted R-square 13.19% 13.51% 14.33% 16.04% 13.53% 13.06% 11.10%

Number of observations 6,273 6,090 5,801 5,183 5,524 5,660 5,562
This table presents OLS regressions of IPO underpricing on country-level earnings quality measures and the interaction of underwriter reputation and earnings
quality for various subsamples. The first four models restrict the sample to IPOs with an offer price above the 2 nd, 5th, 10th and 20th percentile relative to all deals
within a given country, respectively. Models 5, 6, and 7 exclude IPOs listed in the United States, United Kingdom, and Japan, respectively. The dependent
variable is the IPO initial return, which is the secondary market closing price divided by the final offer price, minus one. AggEM is the average country i ranking
across the following four earnings management measures: EM1, EM2, EM3, and EM4. EM1 is the median ratio in country i of the firm-level standard deviations
of operating earnings over the cash flow from operations (both scaled by lagged total assets), multiplied by -1. EM2 is the cross-sectional correlation in country i
between the change in accruals and change in cash flows from operations (both scaled by lagged total assets), multiplied by -1. EM3 is the median ratio in
country i of the absolute value of accruals over the absolute value of cash flow from operations. EM4 is the ratio in country i of the number of firms reporting
small profits over the number of firms reporting small losses. A small profit (loss) is defined as a value of net earnings scaled by lagged total assets in the range
[0, 0.01] ([-0.01, 0)). Underwriter reputation is the country of listing Megginson-Weiss underwriter market share measure, which is the fraction of total CPI-
adjusted offer value underwritten by a given underwriter for the sample. Price stabilization is the difference in the number of IPOs with small positive first day
returns (greater than zero and less than or equal to one percent) and the number of IPOs with small negative first day returns (less than zero and greater than or
equal to negative one percent) divided by the total number of IPOs issued in the country of listing. IPO activity is the ratio of the total number of IPOs in the
issue year divided by the number of Datastream listed equities for the country of listing as of 2006. Market return is the return on the Datastream index for the
country of listing over the three months preceding the offering. Stock market turnover ratio equals the ratio of the total value of shares traded to aggregate market
capitalization and reported in Beck et al. (2000). Underdevelopment is the sum of the rankings of infant mortality, internet users per population, literacy,

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unemployment rate, and paved airport runways as reported by Butler and Fauver (2006). Index of economic freedom is a product of The Heritage Foundation and
The Wall Street Journal and is an aggregate measure covering the following ten freedoms: business, trade, monetary, freedom from government, fiscal, property
rights, investment, financial, freedom from corruption, and labor. Antidirector rights index measures shareholder rights by considering the following issues: (1)
vote by mail, (2) shares not blocked or deposited prior to shareholder meetings, (3) cumulative voting in director elections, (4) oppressed minority mechanisms,
(5) pre-emptive rights to new issues, and (6) minimum capital requirements and is reported in Djankov et al. (2008). Offer size is the natural log of the CPI-
adjusted offer value in millions of U.S. dollars. Indicator variables are set equal to one for integer offer price, bookbuilt, firm commitment, and equity carve-out
deals. Regressions include IPO year and industry dummies. Industry classifications reflect those reported by Dyck and Zingales (2004). Respectively, ***, **,
and * denote significance of the coefficient at the 1, 5, and 10 percent level.

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