The consequences of earnings management for the acquisition premium in friendly takeovers

Abstract

This study investigates the effect of earnings management (EM) on deal premiums in friendly takeovers. It examines both accruals and real EM in the year preceding the deal announcement, based on a sample of 578 European firms subject to an acquisition or acquisition attempt between 2005 and 2015. The empirical findings suggest that downward EM is associated with a higher premium offered by the acquirer. The results suggest that income‐decreasing accounting choices could be a negotiated strategy between the acquirer and target firms’ managers to clean the balance sheet, reduce the likelihood of litigation, and create a fictive performance through an accrual reversal post‐acquisition.

Detecting Earnings Management

“…Managers seeking a buyout minimize earnings to lower the transaction price (DeAngelo, 1986;Perry & Williams, 1994). Firms seeking to be acquired in friendly takeovers tend to manage their earnings downward (Anagnostopoulou & Tsekrekos, 2015;Ben-Amar & Missonier-Piera, 2008;Missonier-Piera & Spadetti, 2022). A higher earnings reduction of the acquired firm is associated with a higher takeover premium (Missonier-Piera & Spadetti, 2022).…”

“…Firms seeking to be acquired in friendly takeovers tend to manage their earnings downward (Anagnostopoulou & Tsekrekos, 2015;Ben-Amar & Missonier-Piera, 2008;Missonier-Piera & Spadetti, 2022). A higher earnings reduction of the acquired firm is associated with a higher takeover premium (Missonier-Piera & Spadetti, 2022). In subsequent years, the firm could increase its earnings by reversing the earnings management (S. .…”