Acquiring firms' earnings management in stock-for-stock mergers within Korean business groups

What is it about?

Many studies report that, in stock-for-stock mergers, acquiring firms have an incentive to engage in upward earnings management to render the stock exchange ratio more advantageous to themselves. This paper investigates the possibility that stock-for-stock mergers between affiliated firms may facilitate the controlling shareholder’s rent-seeking by examining the intra-group mergers unlike the existing literature which focuses on mergers between unaffiliated firms. Using Korean stock-for-stock mergers, we compare pre-merger earnings management of the acquiring firm between mergers of firms belonging to the same family-controlled business group (affiliated firms) and those of independent firms. We find that the pre-merger positive earnings management of acquiring firms is less evident in mergers between affiliated firms. Furthermore, only in mergers between independent firms, the pre-merger earnings management of the acquiring firm is reduced with financial leverage suggesting that creditor monitoring of earnings management is effective only in stock-for-stock mergers between independent firms.

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