Target Firms' Earnings Management And Corporate Performance An Empirical Study In M ? A

Mergers and acquisitions(M?A)are important corporate events.They provide a significant opportunity to corporate groups to achieve a better competitive advantage and significant revenues.However,within the context of M?A,some basic issues are still unresolved.For example,previous evidence suggests that the acquirers do not generally benefit and suffer significant losses in the post-merger periods.The evidence suggests that stock price fluctuations around acquisitions overestimate the future efficiency gains and post-merger abnormal returns are unsettling for the firm.Post-merger underperformance is crucial because it is inconsistent with the concept of efficient capital market.Later studies indicate that the acquirer's earnings management before the merger causes inefficiency in the capital market and negatively affects the post-merger firm performance.These studies indicate that acquirers manipulate earnings to affect the M?A transaction,and according to the rational expectation hypothesis a few studies show that the target firms also likely to manipulate earnings.However,the studies that relate target firm's earnings management to post merger performance are limited.On the other hand from a corrective perspective,the researchers have indicated that the efficiency exists in the ideal markets that are characterized by perfect competition where no individual has power over information and where there is no information asymmetry.In such environment market prices react instantaneously to the information available in the market and therefore,a fully revealing rational expectations equilibrium is achieved and earnings management is mitigated.While revisiting the efficient market anomaly of post-merger poor performance,this dissertation investigates as to whether the target firms also manipulate earnings in addition to acquirers,having a negative effect on acquirer's post-merger performance.The dissertation also investigate as to whether high competition reduces these earnings management activities in firms.This dissertation collects the sample of US public acquisitions for the period between 1987 to 2017.US setting has interesting characteristics as it is the largest M?A market(approximate value 1.37 trillion US dollars)throughout the world(at the time of writing).Moreover,earnings management and reporting behavior have changed dramatically since the introduction of SOX in 2002.The analysis is divided into three related empirical chapters.The first empirical chapter(chapter 3)finds that the target firms engage in accruals and real-activities manipulation prior to an acquisition announcement.Most of the previous studies on this subject have focused exclusively on accruals earnings management;however,the evidence shows that the firms' use of accruals earnings management has decreased after the passage of SOX.Thus,while considering the pre-and post-SOX periods,this chapter shows that real earnings management remains significant during the pre-and post-SOX periods,however accrual earnings management is significant only during the pre-SOX period.To find the impact of target firm's earnings management,the second empirical chapter(chapter 4)extends the analysis and shows that the target firms' pre-merger real earnings management negatively affects the acquirers' long-term performance after controlling for the acquirers' earnings management.Consistent with the rational expectation hypothesis,the research further indicates that the target's short-term returns are negatively associated with the degree of earnings management.Specifically,during the pre-SOX period,accrual and real earnings management both are negatively related to the short-term returns,whereas during the post-SOX period,only real activities manipulation is negatively related to shortterm returns and thus reduces the gains to shareholders.The third empirical chapter(chapter 5)considers the corrective perspective of this research and shows that the firms operating under high product market competition as measured by the Herfindahl-Hirschman index(HHI),conduct less accrual and real earnings management during pre-and post-SOX periods.Specifically,the relation between the real earnings management and competition remains negative and significant in the pre and post SOX periods,whereas,the relation between accrual earnings management and competition becomes insignificant in the post SOX period.Moreover,after incorporating the effect of corporate governance and SOX,this research shows that the acquirers operating in high competitive industries experience better short term announcement returns(short term performance).This dissertation first contributes to the earnings management literature and provides evidence that the target firms exhibit significant accrual and real earnings management.Previous literature shows that target firms use accrual earnings management in stock based acquisitions and sales manipulation in cash acquisitions before the announcement date of the merger.The current research investigates cashbased and stock-based(mixed)acquisitions and provide additional evidence of the target firms' use of accrual and real earnings management(abnormal level of inventory and abnormal level of discretionary expenses)during the pre and postSOX period.This research shows that accrual earnings management is significant in target firms of stock-based acquisitions during the pre-SOX period only,while it is insignificant in target firms of cash acquisitions and during the post-SOX period.While the real earnings management remains significant during both periods.Moreover,unlike previous studies,this research investigates earnings management in quarters surrounding the announcement dates and hence provide stronger evidence around the merger announcement.Secondly,this dissertation extends the literature related to the acquirer's postmerger performance and shows that target firms' pre-merger real activities manipulations(Abnormal inventory/production and abnormal discretionary expense),cause the acquiring firms to underperform during both pre-and post-SOX periods.Previous researchers provide evidence of the acquirer's post-merger negative performance but do not adjust for the acquirer's earnings management.This adjustment is important because according to the previous literature,the acquirers also manipulate earnings resulting in negative performance.Therefore,current research takes into account this adjustment among other control variables and provides an explanation for the post-merger negative performance.Moreover,current study also estimates the industry-adjusted accounting performance and shows that acquiring firms' operating performance is weaker during the post-merger period.This research also provides an analysis of the relation between the target's earnings management and short-term returns to the shareholder.Previous studies only examine the effect of acquirer's earnings management on short-term returns and provide mixed findings on a positive and a negative relationship.The current study investigates the relationship between a target's earnings management and short-term returns and show that investors rationally undo the effect of earnings management when a merger is announced,and decrease the stock prices resulting in a drop of returns and reducing the gains to shareholders.Thirdly,this dissertation contributes to the literature on the effect of product market competition on previously discussed issue of earnings management.Previously,the researchers indicate a negative relationship between product market competition and earnings management by firms involved in share repurchase.The current research extends the literature and shows that competitive pressures from the product market reduce earnings management before acquisitions announcement.The current research also controls for the governance mechanism and SOX,and shows that the negative relation between market competition and earnings management remains.Specifically,the research reveals that high competition negatively affect the real earnings management in both the pre-and post-SOX periods,whereas the effect on accrual earnings management is significant only in the pre-SOX period.The previous study shows that poor governance results in unprofitable acquisitions and acquiring firms experience lower announcement returns.However,current study considers SOX and indicates that high competition has a positive effect on the acquiring firm's short-term announcement returns in the pre and post SOX periods,and the acquiring firms in non-competitive industries do not experience lower announcement returns after SOX.These results suggest that product market competition can act as substitute for corporate governance and is mostly beneficial in non-competitive industries.Moreover,under competitive pressures earnings management is reduced,and acquiring firms make better acquisitions.The findings of this dissertation have important implications for regulators,policymakers,shareholders,auditors,board of directors,and financial advisors.This dissertation highlights that the manipulation by target firms includes real operating decisions related to production and discretionary expenses.The firms might experience temporary benefits,but this manipulation,as discussed in the existing literature,harms their long-run competitiveness and profitability.Therefore,monitoring bodies should pay attention to activities related to abnormal levels of production and expenditures at firms that are the targets of M?A transactions.Moreover,the disciplinary pressures of product market competition help align the managerial incentives,reduce earnings management behavior and thus act as an external governance mechanism.Therefore,the policymakers should pay more attention to non-competitive industries in improving their corporate governance practices.Furthermore,efforts should be broadened to include measures that could improve the industry's competitiveness.