Research on initial public offerings (IPOs) generally suggests that company performance deteriorates after going public. For example, Aggrawal and Rivoli (1990) find that IPO long-run performance is worse than the market performance. They argue that the IPO long-run under performance may be result from fads or speculative bubbles in the early aftermarket stage. Ritter (1991) and Loughran and Ritter (1995) document that IPOs in the U.S. under perform significantly relative to non-issuing matching firms for three to five years after the listing date. Loughran, Ritter and Rydqvist (1994) even consider the IPO under performance is an international phenomenon. Many researchers have also documented a long-run decline in firms’ post-IPO operating performance. Jain and Kini (1994 and 1995), Mikkelson, Partch and Shah (1997) and Pagano, Panetta and Zingales (1998) have done so for the U.S. market. They indicate that long-run return performance is also accompanied by poor accounting performance post-IPO relative to pre-IPO performance and/or industry conditions. The received wisdom is that IPO firms tend to perform poorly after the offerings in the operating respect.

This study conjectures that earnings management behavior during lockup is crucial to the pattern of aftermarket operating under performance. The lockup ensures that the insiders wealth is connected to the fortunes of the IPO firm for a regulated period of time, and thus prompts insiders to overstate their profitability in lockup period by engaging earnings management (Teoh, Wong and Rao, 1998; Huang and Lin, 2007). In addition, Teoh et al. (1998) and Teoh, Welch and Wong (1998a) document significant positive discretionary accruals (DA) in the IPO year and the following year. Both the insiders incentive to preserve investors confidence in the newly established firm and the evidence of post-issue earnings management motivate the hypothesis that stock lockup plays an important role in explaining the pattern of post-issue deterioration in operating performance.