Acquirers’ earnings management ahead of stock-for-stock bids in ‘hot’ and ‘cold’ markets

Abstract

The accounting literature has found evidence that acquirers in stock-for-stock M&A have typically managed earnings upwards ahead of a bid. Other literatures have concluded that, when stock prices are high and rising, M&A is higher, more M&A is financed with stock, market sentiment and stockholders' perceptions of information appear to change, and in these circumstances new (arbitrage) motivations for M&A emerge. This paper revisits earnings management ahead of M&A in the light of these findings, comparing experience in 'hot' and 'cold' markets. It finds that such earnings management is more pronounced in hot markets; that only in such markets are positive discretionary accruals commonly associated with positive abnormal returns on the announcement of earnings; and that in such markets-against the expectations from signalling theory-these positive returns are not reversed on announcement of a stockfor-stock bid. The results suggest that the economic benefits achieved by engaging in earnings management during hot markets are indeed significant: in hot markets, we estimate that on average share acquirers engage in working capital accrual management equivalent to over a third of the average acquirer's return on total assets in that year; and that this earnings management is associated with increases in market value which are statistically and economically significant, enabling the bidder to secure control of the target with fewer shares.

Risk‐Taking Incentives and Earnings Management: New Evidence*

“…Thus, the direct benefit of managing earnings—for example, decreased risk of job termination, increased share, option values, and so forth—is incrementally higher during expansions as the price impact per dollar of managed earnings is greater. Consistent with this reasoning, an extensive line of research finds earnings management is higher when investors are most likely to react to it (Rajgopal et al 2007; Botsari and Meeks 2018; Simpson 2013; Ali and Gurun 2009). 16…”

Bidder earnings forecasts in mergers and acquisitions

“…This will be particularly important to target shareholders when the bidder's stock is highly valued, which a stock offer usually signals (Shleifer and Vishny 2003;Rhodes-Kropf and Viswanathan 2004;Di Giuli 2013). 2 The literature also suggests that, in stock bids, the past record of the bidder may previously have been flattered by earnings management (Erikson and Wang 1999;Botsari and Meeks 2008;Botsari and Meeks 2018). As the vast majority of stock-for-stock and mixed payment deals in the US have a fixed exchange ratio (Gaughan 2011;Ahern and Sosyura 2014), the actual value target shareholders receive will only be determined upon completion of the deal based on the prevailing share price of the acquirer.…”

Death on the stock exchange: The fate of the 1948 population of large UK quoted companies, 1948–2018

“…For example, the UK economy was stronger in the 1960s than in the 1970s, and in the decade up to 2008 than in the one after. It could be that there are offsetting mechanisms: recession brings more business failures (Goudie & Meeks, 1991), and 'scavenger' takeovers of moribund firms; while stock market booms are associated with opportunistic takeovers in which bidders exchange their highly priced shares for targets (Botsari & Meeks, 2018;Shleifer & Vishny, 2003). This would be a promising area for further research.…”