This study explores how firms' ownership structures affect their earnings quality and long-term performance. Focusing on a unique sample of private firms for which there is financial data available in the years before and after their initial public offering (IPO), I differentiate between those that have private equity sponsorship (PE-backed firms) and those that do not (non-PE-backed firms). The findings indicate that PE-backed firms generally have higher earnings quality than those that do not have PE sponsorship, engage less in earnings management, and report more conservatively both before and after the IPO. Further, PE-backed firms that are majority-owned by PE sponsors exhibit superior long-term stock price performance after they go public. These results stem from the professional ownership, tighter monitoring, and reputational considerations exhibited by PE sponsors.

We compare the quality of accounting numbers produced by two types of public firms—those with publicly traded equity and those with privately held equity that are nonetheless considered public by virtue of having publicly traded debt. We develop and test two hypotheses. The “demand” hypothesis holds that earnings of public equity firms are of higher quality than earnings of private equity firms due to stronger demand by shareholders and creditors for quality reporting. In contrast, the “opportunistic behavior” hypothesis posits that public equity firms, because their managers have a greater incentive to manage earnings, have lower earnings quality than their private equity peers. The results indicate that, consistent with the “opportunistic behavior” hypothesis, private equity firms have higher quality accruals and a lower propensity to manage income than public equity firms. We further find that public equity firms report more conservatively, in line with their greater litigation risk and agency costs.

Prior evidence shows a reduction in leverage after covenant violations, but we do not know whether covenants affect leverage before they are violated. In this study, we use an exogenous accounting-based shock to debt covenants that relaxed covenant tightness (SFAS 160) and examine whether covenants constrain leverage for borrowers that are close to violation, even when the borrower is financially healthy. We find that SFAS 160 increased debt levels in firms that were close to violation. This increase in debt was driven by financially healthy firms, suggesting the likelihood of future covenant violations could impede borrowing by firms. We also find an increase in investment sensitivity to Q after SFAS 160 in firms close to violation, suggesting the additional debt was used to make legitimate investments. Because SFAS 160 was passed in the midst of the financial crisis, it is difficult to generalize our findings to more normal financial periods.

In this study, we develop a measure of corporate tax avoidance that reduces both financial and taxable income, which we refer to as “book-tax conforming” tax avoidance. We use simulation analyses, LIFO/FIFO inventory method conversions, and samples of private and public firms to validate our measure. We then investigate the prevalence of conforming tax avoidance within a sample of public firms. Results from the validation tests indicate that our measure of conforming tax avoidance successfully captures book-tax conforming transactions. Consistent with expectations, we also find that the extent to which public firms engage in conforming tax avoidance varies systematically with the capital market pressures. Our study develops a new measure of conforming tax avoidance that should be useful in future research and provides new insights on the extent to which public firms are willing to reduce income tax liabilities at the expense of reporting lower financial income.