Earnings management detection of a target in merger and acquisition deals: Case of Russian companies

Abstract

The goal of this study is to examine how acquirers can detect earnings management of a target in Russia in the quarters/years preceding the announcement of M&A deal and to develop the corresponding methodology. The relevance of the topic is explained by the inability of existing methods to detect earnings management with regard to a particular company. To achieve the desired goal, the following objectives are formulated: Analysis of existing methods for earnings management detection and their applicability to a target in M&A deal in Russia; Development of Monte Carlo approach for earnings management detection; Development of the methodology of earnings management detection of a target in M&A deal in Russia on the example of OJSC Concern “Kalina” acquired by PLC Unilever in 2011 and PJSC EMAlliance acquired by OJSC Power Machines in 2012. Application of Monte Carlo approach showed that probability of earnings management exercised by Kalina is low contrary to the results of aggregate accruals models and indicated upward earnings management of EMAlliance confirming the results of aggregate accruals models. The methodology developed proposes to use aggregate accruals models as “red flags” and apply Monte Carlo approach to look at probability of earnings management.