Accrual and real-based earnings management by UK acquirers

Abstract

Methodology: Mean and median accrual and real-based manipulation are examined in the period before the announcement of a merger and acquisition. These are compared across stock and cash acquirers as well as before and after the implementation of the Higgs recommendations. We also run logistic regressions to examine accrual and realbased manipulation across stock and cash acquirers after controlling for variables that may impact the acquisition type. Findings:We find some evidence of upward pre-merger accrual-based earnings management by stock-financed acquirers, which is in line with the findings of Botsari and Meeks (2008). Furthermore, we do not find significant changes in the post-Higgs period which indicates that the recommendations put forth by Higgs may not have been successful in mitigating earnings management. Our evidence also shows that cash bidders engage in pre-merger real earnings manipulation through lower discretionary expenses, possibly to enhance cash availability for the bid. 2Practical implications: The findings in this study confirm earnings management exists around mergers and acquisitions and provide some evidence that the recommendations set out in the Higgs Report do not appear to have mitigated earnings management activities. This is of interest to regulators as well as investors and academicians.Originality: This provides the first analysis in the UK examining the use of real-based earnings management activities by UK acquirers. It also extends prior research around corporate governance changes that occurred in the UK. IntroductionEarnings management has been extensively examined through a stream of research that considers firms involved in specific corporate events (such as seasoned equity offerings, initial public offerings and management buyouts). This study extends prior results on earnings management in mergers and acquisitions (hereafter M&As) that engage in either cash or stock bids; and examines the prevalence of accrual and real-based earnings management in this context. Furthermore, we examine whether regulatory changes in the UK following the Higgs (2003) report have an impact on earnings management in this context.Though prior research has examined accrual-based manipulation in the M&A context in the US (such as Erickson and Wang, 1999; Louis, 2004) in the UK (Botsari and Meeks, 2008), and in the Asia-pacific region (Ardekani et al., 2012;Higgins, 2013;Jeong and Bae, 2013), only limited studies have extended its scope to examine whether acquiring firms engage in the manipulation of real activities (e.g. Zhang, 2015). Therefore, a comprehensive study that considers both accrual and real-based earnings management practices is needed to contribute to earnings management research in the UK M&A context. Furthermore, fundamental changes to governance codes around the world have occurred over the past few years. For example, the enactment of the Sarbanes-Oxley Act in the US; the UK Corporate Governance Code in the UK based on the recommendations set out in the Higgs Report (2003)...

Real earnings manipulation surrounding mergers and acquisitions: the targets’ perspective

“…The majority of studies examining EM ahead of M&As focus on earnings manipulation strategies of the acquirer, finding that acquiring firms manage earnings upwards prior to stock-for-stock transactions in an effort to increase their stock price and reduce the number of shares issued in exchange (Erickson and Wang, 1999; Louis, 2004; Baik et al , 2007; Gong et al , 2008; Botsari and Meeks, 2008; Higgins, 2013; Kassamany et al , 2017). However, less attention has been paid to EM by targets and their motivations in doing so.…”

“…As far as the literature on EM around M&As is concerned, AEM by acquirers has been examined (Botsari and Meeks, 2008; Higgins, 2013; Kassamany et al , 2017), and not much attention has been paid to targets’ EM. Prior studies that examine EM by targets find mixed evidence as to the presence of such manipulation in the period prior to the announcement of the deal, which does not present convincing and persuasive reasons to challenge the presence of EM by takeover targets.…”

Audit quality and real earnings management: evidence from the UK manufacturing sector

“…For example, fundamental changes to corporate governance code have occurred in the UK. The UK Corporate Governance Code based on the recommendations set out in the Higgs (Kassamany et al , 2017) attempt to address these accounting scandals. Consequently, a study that sheds further insight on real earnings management and audit quality is very relevant, as real earnings management is one of the scandal perpetrated by managers.…”

Internal audit role on information asymmetry and real earnings management

“…Earnings management is an option taken by management in accounting policies used to achieve a particular goal (Scott 2015). Earnings management is undertaken in various ways such as taking a bath, income minimization, income maximization, and income smoothing (Kassamany et al 2017). Two common types of earnings management are accrual earnings management and earnings management through real activities manipulation which is also called real earnings management.…”

“…The researches have examined whether exposure media and corporate actions such as dividen polity, IPO affect accruals earnings management. Meanwhile, there is a limited research of earnings management using real activities in manipulating earnings (Kassamany et al 2017;Eldenburg et al 2011;Ge and Kim 2014;Aslani et al 2014;Rizvi and Khan 2015).…”