Do companies manage earnings ahead of stock-for-stock acquisitions? Recent evidence from the UK

Abstract

OBJECTIVES OF THE STUDY:

In this thesis I study the earnings management phenomenon in conjunction with stock-for-stock acquisitions. I also examine certain acquirer and target company characteristics that have an effect on the magnitude of stock acquirers' discretionary accruals. The objective of this thesis is to expand academic understanding on earnings management and to provide explanations on management incentives to report adjusted figures ahead of acquisitions. Further, understanding the motives and magnitude of managed earnings helps academia, regulators and investors at large to better comprehend the acquirer underperformance puzzle.

DATA AND METHODOLOGY:

My sample consists of 231 stock-for-stock corporate acquisition deals conducted in the United Kingdom between 2005 and 2012, inclusively. The time period of my study accounts for both times of economic growth and decline. Further, the international setting of my thesis when studying earnings management in the UK expands the existing academic research, which has so far mainly focused on the US market. I use a variety of accounting and statistical models to estimate the magnitude of discretionary accruals for the acquirers, for which the Jones (1991) model provides the most important foundation. Further, with various ordinary least squares regression models I examine certain company and deal characteristics that have an effect on the magnitude of managed earnings as well as on acquirer cumulative abnormal returns obtained from the market model. Finally, I compare the findings from my main sample event companies to non-event companies control group to further validate the results.

FINDINGS OF THE STUDY:

I conclude that the earnings management models I use in this research are capable of detecting opportunistic earnings management in stock-for-stock acquiring companies prior to the deal announcements. Further, I find that acquirers using stock as the payment method for transactions manage earnings upwards ahead of their acquisition announcements in order to benefit from higher share price, which determines the total price paid for the target. One factor that has an increasing effect on pre-deal earnings management is subpar acquirer operating performance during reporting periods before the deal announcement. The negative relationship implies that as company profitability increases it resorts less to managing earnings. Conversely, a target company's relative size has an increasing effect on the acquirer pre-deal earnings management. Finally, acquirer abnormal returns around the deal announcement date are depressed partly due to pre-deal earnings management, which investors expect when a stock deal is announced. The negative relationship between the magnitude of pre-deal earnings management and the acquirer abnormal returns becomes more pronounced around a half a year after the deal is announced.