M&A Due Diligence, Post‐Acquisition Performance, and Financial Reporting for Business Combinations

Abstract

Before completing merger and acquisition (M&A) transactions, acquiring firms conduct due diligence. This process provides acquiring firms with a more informed assessment of the expected costs, benefits, and risks of an acquisition and offers one last opportunity to renegotiate or terminate an M&A transaction. However, acquiring firms must trade off the costs and benefits of performing additional due diligence versus completing the acquisition. Based on an analysis of the time to negotiate the acquisition agreement and complete the transaction, I predict and find that competitive pressures, short‐term financial reporting incentives, and agency problems are associated with less due diligence. I also find that less due diligence is associated with lower post‐acquisition profitability, a higher probability of acquisition‐related goodwill impairments, and lower quality fair value estimates for the acquired assets and liabilities. These findings highlight due diligence as an important factor explaining cross‐sectional variation in post‐acquisition performance and financial reporting for business combinations.

Post-M&A Performance and Failure: Implications of Time until Deal Completion

“…Wangerin shows that less due diligence is associated with lower post-merger profitability and indicates a monotonic relationship between due diligence and profitability [7]. We show further in addition to his findings that beyond an optimal deal closing time, the acquirer also suffers low post-merger profitability indicating the presence of a non-monotonic relationship.…”

“…Effective due diligence is taken by the acquirer to satisfy itself of the validity of the representation and warranties made by the target in the deal provisions. Wangerin indicates that due diligence enables the acquirer to verify that no "material adverse event" has occurred that would be detrimental to the value of the target firm [7]. He further shows that less due diligence is associated with lower post-merger profitability.…”

“…The due diligence hypothesis posits that a deal may take a long time to complete after its announcement because the acquirer has undertaken rigorous due diligence to ensure a proper close. This due diligence process provides acquiring firms with a more informed assessment of the expected costs, benefits, and risks of acquisition and grants them the opportunity to renegotiate or terminate bad deals [7]. If the due diligence hypothesis holds, then the deal should experience higher gains and be associated with a higher likelihood of survival post-M&A, while deals for which due diligence is not undertaken should be associated with lower performance outcomes and increased failure likelihood.…”

The role of auditors in merger and acquisition completion time

“…Their findings suggest that high‐quality accounting information facilitates M&A for targets and therefore reduces the amount of time required for due diligence. Wangerin () highlighted the importance of due diligence in M&A transactions. His findings suggest that acquirers completing M&A transactions faster than expected perform less due diligence and, consequently, exhibit lower postacquisition performance.…”

“…Our study contributes to the extant literature in two main ways. First, we contribute to the growing literature examining factors that could affect M&A completion time (Hunter & Jagtiani, ; Golubov, Petmezas, & Travlos, ; Agrawal et al, ; Amel‐Zadeh & Zhang, ; Jagtiani, Kotliar, and Maingi (); Marquardt & Zur, ; Wangerin, ). To our knowledge, it is one of the first studies using office‐level audit data to examine how auditors use their M&A experience to reduce deal time and effort.…”