Earnings management in companies seeking to be acquired and its effect on chances of subsequent acquisition

Abstract

Earnings management is found to be widely used by managers to alter financial reporting, whereas managers of seeking buyer firms might have particularly strong incentives to do so. The goal of the current Master thesis is to analyze an influence of accrual-based earnings management strategies and other factors on ex ante chances of subsequent acquisition of a target company that publicly announces that it is in search for a buyer. We study the sample of seeking buyer firms that issued respective announcements in years 2010 through 2012. We first estimate amount of discretion on the basis of elaborated industry-specific aggregate accrual models, and then define the factors of a successful sale by means of binary logistic and IV regressions. We find that acquirers are eager to bid for companies which are profitable and in a good financial state, but only when the latter reflect firm fundamentals, and is not achieved via accrual manipulation. The results of the analysis allow us to formalize a portfolio of recommendations for managers at seeking buyer companies, which depend on the financial state of the firm.