Ownership structure, Earnings Management and Acquiring Firm Post-Merger Market Performance
FRANCOEUR C., W. BEN AMAR and P. RAKOTO, 2011. Ownership structure, Earnings Management and Acquiring Firm Post-Merger Market Performance: Evidence from Canada. Forthcoming in International Journal of Managerial Finance.
Abstract
This study investigates the link between ownership structure, earnings management (EM) preceding mergers and acquisitions (M&A) and acquiring firm’s subsequent long-term market performance. We measure the magnitude of discretionary current accruals using two methodologies, that of Teoh et al. (1998a, 1998b) and that of Kothari et al. (2005). The latter methodology is used to control for the presence of extreme performance prior to the event. We use the calendar-time Fama-French three-factor model to evaluate long-term stock performance and to minimize potential problems related to the cross-sectional dependence of the returns. We find that firms using stock as a financing medium exhibit significant positive discretionary accruals during the year preceding the M&A and during the year of the acquisition. We also document that voting right concentration and control enhancing mechanisms are not associated with any significant level of earnings management. Finally, we find a negative association between EM and abnormal stock returns over a three-year period following the acquisition. This study extends prior literature by taking a closer look at dominant shareholders’ motivations to manage earnings in stock-financed M&A. Large shareholders have strong incentives to manage earnings upward prior to stock-financed transactions to limit the dilution of their controlling position. Our results highlight the importance of maintaining good legal and extra-legal protection of minority shareholders. Regulators can play an important role in preventing dominant shareholders from engaging in opportunistic EM in stock-financed M&A.
