Does Investment-Related Pressure Lead to Misreporting? An Analysis of Reporting Following M&A Transactions

Abstract

This study examines whether managers alter their financial reporting decisions in the face of investment-related pressure. We define investment-related pressure as the increased pressure managers feel to retain their job following an M&A poorly received by the market. We hypothesize that managers attempt to assuage pressure by delivering strong performance post-merger, creating incentives for misreporting. Our findings indicate that acquirers with more negative M&A announcement returns are more likely to misstate financial statements in the post-investment period and the issuance of misstated financials mitigates this pressure, at least in the near term. Our study contributes to the literature on the relation between corporate investing and financial reporting by showing how investment-related pressure leads to misreporting, even in a setting where the costs (e.g., greater probability of detection) are high. Our study also has implications for the large body of research that evaluates various consequences of M&As using post-merger performance. Specifically, researchers should be careful to distinguish real from misstated financial performance in the post-investment period. Data Availability: Data are available from the public sources indicated in the text.

Common auditors in M&A transactions

“…We also find less misreporting for common-auditor mergers, the third mechanism, using performance-matched abnormal accruals (Kothari et al, 2005) and financial statement restatements (Bens et al, 2012) as proxies for misreporting. Combined, these results support our inferences that common auditors reduce uncertainty in the M&A process by improving (public and private) communication channels.…”

“…Following Bens et al (2012), we eliminate all clerical application errors and include only accounting rule application failures and financial fraud to ensure that our sample includes material GAAP misapplications and not unintentional reporting errors. We use information about the beginning date of the misstatement period to identify earnings misstatements within a two-year window before the merger completion.…”

“…To determine whether there is less misreporting for common-auditor M&As relative to non-common-auditor M&As, we use performance-matched abnormal accruals (Kothari et al, 2005) and financial statement restatements (Bens et al, 2012) as proxies for misreporting. For the accrual analysis, we examine both acquirer and target accruals; however, for the restatement analysis, we examine restatements made by the newly merged firm.…”

M&A Decisions and US Firms’ Voluntary Adoption of Clawback Provisions in Executive Compensation Contracts

“…Firms adopt clawback provisions to recover executive compensation tied to earnings that are subsequently revised downward (i.e., restatements). Prior research documents that when executives make poor M&A decisions, there is a greater likelihood of managers manipulating earnings in the post‐acquisition period and thus a greater likelihood of earnings restatements (Bens et al., ). We therefore posit that corporate boards are more likely to voluntarily adopt clawback provisions following M&A transactions that are viewed negatively by investors as a mechanism to deter the manipulation of post‐acquisition earnings.…”

Management Forecast Quality and Capital Investment Decisions

“…Similarly, Durnev andMangen (2009), McNichols andStubben (2008), Biddle et al (2009), Bens, Goodman, andNeamtiu (2012), Badertscher, Shroff, and White (2013), Shroff, Verdi, and Yu (2013) and Shroff (2013) provide arguments and evidence linking external reporting to internal investment decisions. However, none of these studies examine the relation between managers' voluntary disclosure quality and the quality of their internal investment decisions.…”