The Exit of Venture Capital and Financial Disclosure in Newly-Public Firms

This study addresses the relation between the exit of venture capital and opportunistic behavior in financial disclosure. Specifically, I examine whether the exit of venture capital is associated with income-increasing earnings management in the IPO year and financial statement restatements related to the period prior to the exit of venture capital. After controlling for the endogenous choice of exit, I document that, consistent with earnings management, the exit of venture capitalists (VCs) is significantly positively related to performance-matched discretionary accruals in the IPO year. Regardless of VCs exiting, their stockholdings prior to the expiration of the lockup period are negatively related to discretionary accruals in the IPO year. Surprisingly, VC representation on the audit committee has no significant relation with income-increasing earnings management.Restatements are less likely to happen prior to or during the period of VCs exit, and more likely to happen after VCs exiting. My results support this hypothesis. I find that the exit of venture capital right after the lockup expiration is negatively associated with the probability of announcing a restatement in the period T1, but positively associated with the probability of announcing a restatement in the period T2. More importantly, the exit of venture capital has a significant impact on the relation between VCs stockholdings and the probability of announcing a restatement prior to VCs exiting. Only for firms with VCs exiting, does VC representation on the audit committee have a significantly negative association with the probability of announcing a restatement prior to VCs exiting. Neither VCs holdings nor VCs representation on the audit committee has a significant relation with the probability of announcing a restatement after the exit of venture capital.The associations I find are robust to the usage of different instruments for the exit of venture capital, different measure for discretionary accruals, the inclusion of control variables for the intended use of proceeds, auditors characteristics and CEOs incentives to manage earnings.Finally, my results indicate that as in the case without VC exit, firms with VCs exiting have similar abnormal stock returns during the lockup period and for the period from the lockup expiration through the record date of the first proxy available thereafter. The exit of venture capital is associated with a lower likelihood of securities class action after the IPO. In addition, I find some evidence that income-increasing earnings management imposes some costs on venture capitalists, e.g., fewer new IPOs and greater underpricing for new IPOs.Overall, my findings suggest that litigation risk and reputation cost are not strong enough to restrain venture capitalists from pursuing the benefits of opportunistic behavior in financial disclosure.