Do Lockups Constrain Earnings Management in IPOs?

Initial public offering (IPO) firms typically employ lockups to mitigate information asymmetry and agency problems that plague new equity issues. This paper examines association between lockup length and the level of earnings management in IPOs. We contend that with significant liquidity and portfolio non-diversification costs, longer lockups remove insiders’ incentives for earnings management to avoid potential wealth losses at lockup expiry. Consistent with this argument, we document a significant inverse relationship between earnings management and lockup length for a sample of UK IPOs over 1995-2006. Longer lockups effectively reduce earnings management and this result is invariant to adjustments for potential endogeneity of lockups and alternative proxy for earnings management. Overall, our evidence suggests that lockup length acts as an important constraint to opportunistic earnings management around equity issues.