Earnings management as a predictor of mergers and acquisitions withdrawal

What is it about?

This study investigates the effect of accrual-based and real earnings management practices on the likelihood of M&A deal withdrawal, highlighting the role of financial reporting quality in the acquirers decision-making.Using a dataset of 1,611 listed nonfinancial EU target firms involved in completed or withdrawn M&A, we implement a logistic regression model to investigate the relationship between earnings manipulation and deal outcomes.

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Why is it important?

Our findings indicate that target firms engaging in aggressive manipulation practices through accruals, production cost and sales in the period preceding the deal announcement are significantly associated with increased deal withdrawal risk. This demonstrates acquirers’ ability to detect earnings management and incorporate this information into their decision-making process. Furthermore, the influence of earnings management on withdrawal probability remains consistent in conditions of high information asymmetry deriving from the national and industry differences, suggesting that acquirers can effectively evaluate target firms financial quality despite limited information. An additional analysis revealed that when target firms operate in common-law countries and regulated sectors, the impact of earnings management on deal withdrawal becomes insignificant. This finding is likely related to the limited opportunities for misleading practices in such business environments. In contrast to previous research that primarily focused on accrual-based models, this study innovates using both accrual and real earnings management, offering a comprehensive perspective on target firms’ manipulation tactics. This aspect, combined with the selected sample, establishes an innovative approach to the topic of M&As, contributing to enhancing the current literature and providing new research avenues.

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