Effects of Venture Capital Network Centrality on Earnings Management During an IPO Lockup: Evidence from the US Market
Keywords:
Venture capital, earnings management, network centralityAbstract
This study investigates the effects of the network centrality of a venture capital firm (VC) on the earnings management level of portfolio companies, focusing on the IPO lock-up period. The results suggest that companies backed by VCs with higher network centrality are more likely to use accrual-based earnings management during the lock-up period. In contrast, this same relationship does not exist with real earnings management. Furthermore, we do not see the same connection in periods other than the lock-up. The lock-up period is unique, as its expiration is the first opportunity for VCs to sell shares to public investors; thus, there is an incentive for VCs and managers to manage earnings just before the expiration of the IPO lock-up period. This study contributes to our understanding of how entrepreneurs seek investment. It suggests that engaging with a more centralized VC may not be preferable, given that the degree of earning management is higher. For limited partners looking to invest in VC funds, due diligence should focus on the financial performance and transparency of VCs with higher network centrality, especially during the lock-up period. Finally, this study provides guidelines for designing a more effective policy to address earnings management problems at IPO for VC-backed companies.
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