Menu Expand

Cite JOURNAL ARTICLE

Style

Mughal, A., Haque, A., Zahid, Z., Ali, F., Li, Z. Does Target Firm’s Earnings Management Affect Shareholder’s Gains? Evidence from China. Credit and Capital Markets – Kredit und Kapital, 55(2), 203-226. https://doi.org/10.3790/ccm.55.2.203
Mughal, Azhar; Haque, Abdul; Zahid, Zohaib; Ali, Furman and Li, Zheng. "Does Target Firm’s Earnings Management Affect Shareholder’s Gains? Evidence from China" Credit and Capital Markets – Kredit und Kapital 55.2, 2022, 203-226. https://doi.org/10.3790/ccm.55.2.203
Mughal, Azhar/Haque, Abdul/Zahid, Zohaib/Ali, Furman/Li, Zheng (2022): Does Target Firm’s Earnings Management Affect Shareholder’s Gains? Evidence from China, in: Credit and Capital Markets – Kredit und Kapital, vol. 55, iss. 2, 203-226, [online] https://doi.org/10.3790/ccm.55.2.203

Format

Does Target Firm’s Earnings Management Affect Shareholder’s Gains? Evidence from China

Mughal, Azhar | Haque, Abdul | Zahid, Zohaib | Ali, Furman | Li, Zheng

Credit and Capital Markets – Kredit und Kapital, Vol. 55 (2022), Iss. 2 : pp. 203–226

Additional Information

Article Details

Author Details

Dr. Azhar Mughal, Assistant Professor, The Institute of Management Sciences, Lahore Pakistan, Postcode 54000, and Researcher, Southwestern University of Finance and Economics, Chengdu, China Postcode 611130, +86 137 39499643, +92 320 4511678.

Dr. Abdul Haque, Associate Professor, COMSATS University Islamabad Lahore Campus, Lahore Pakistan, Postcode 54000, +92 333 4203330.

Zohaib Zahid, Southwestern University of Finance and Economics, Chengdu, China Postcode 611130, +86 137 39499247.

Furman Ali, Southwestern University of Finance and Economics, Chengdu, China Postcode 611130, +86 155 28384305.

Zheng Li (Corresponding Author), Sichuan Industrial Revitalization Development Investment Fund Co. Ltd, Chengdu, China, Postcode 610095, +86 28 85323231.

References

  1. Ambrose, B. W./Megginson, W. L. (1992): The role of asset structure, ownership structure, and takeover defenses in determining acquisition likelihood. Journal of financial and quantitative analysis, Vol. 27(4), 575–589.  Google Scholar
  2. Anagnostopoulou, S. C./Tsekrekos, A. E. (2015): Earnings management in firms seeking to be acquired. British Accounting Review, Vol. 47(4), 351–375.  Google Scholar
  3. Anilowski, C./Macias, A. J./Sanchez, J. M. (2009): Target firm earnings management and the method of sale: Evidence from auctions and negotiations. SSRN eLibrary.  Google Scholar
  4. Antoniou, A./Arbour, P./Zhao, H. (2008): How much is too much: are merger premiums too high? European Financial Management, Vol. 14(2), 268–287.  Google Scholar
  5. Asquith, P. (1983): Merger bids, uncertainty, and stockholder returns. Journal of Financial Economics, Vol. 11(1), 51–83.  Google Scholar
  6. Barth, M. E./Elliott, J. A./Finn, M. W. (1999): Market rewards associated with patterns of increasing earnings. Journal of Accounting Research, Vol. 37(2), 387–413.  Google Scholar
  7. Bartov, E./Givoly, D./Hayn, C. (2002): The rewards to meeting or beating earnings expectations. Journal of Accounting and Economics, Vol. 33(2), 173–204.  Google Scholar
  8. Bartov, E./Gul, F. A./Tsui, J. S. (2000): Discretionary-accruals models and audit qualifications. Journal of Accounting and Economics, Vol. 30(3), 421–452.  Google Scholar
  9. Ben‐Amar, W./Missonier‐Piera, F. (2008): Earnings management by friendly takeover targets. International Journal of Managerial Finance, Vol. 4(3), 232–243.  Google Scholar
  10. Botsari, A./Meeks, G. (2008). Do acquirers manage earnings prior to a share for share bid? Journal of Business Finance & Accounting, Vol. 35(5–6), 633–670.  Google Scholar
  11. Bowman, R. G./Navissi, F. (2003): Earnings management and abnormal returns: Evidence from the 1970–1972 Price Control Regulations. Accounting & Finance, Vol. 43(1), 1–19.  Google Scholar
  12. Burgstahler, D./Dichev, I. (1997): Earnings management to avoid earnings decreases and losses. Journal of Accounting and Economics, Vol. 24(1), 99–126.  Google Scholar
  13. Carey, P./Simnett, R. (2006): Audit partner tenure and audit quality. Accounting review, Vol. 81(3), 653–676.  Google Scholar
  14. Cohen, D. A./Zarowin, P. (2010): Accrual-based and real earnings management activities around seasoned equity offerings. Journal of Accounting and Economics, Vol. 50(1), 2–19.  Google Scholar
  15. Cooper, L. A./Downes, J. F./Rao, R. P. (2018): Short term real earnings management prior to stock repurchases. Review of Quantitative Finance and Accounting, Vol. 50(1), 95–128.  Google Scholar
  16. DeAngelo, L. E. (1986): Accounting numbers as market valuation substitutes: A study of management buyouts of public stockholders. Accounting review, 400–420.  Google Scholar
  17. DeAngelo, L. E. (1988): Managerial competition, information costs, and corporate governance: The use of accounting performance measures in proxy contests. Journal of Accounting and Economics, Vol. 10(1), 3–36.  Google Scholar
  18. Dechow, P. M./Sloan, R. G./Sweeney, A. P. (1995): Detecting earnings management. Accounting review, 193–225.  Google Scholar
  19. DeFond, M. L./Jiambalvo, J. (1994): Debt covenant violation and manipulation of accruals. Journal of Accounting and Economics, Vol. 17(1–2), 145–176.  Google Scholar
  20. Dehejia, R. H./Wahba, S. (2002): Propensity score-matching methods for nonexperimental causal studies. Review of Economics and statistics, Vol. 84(1), 151–161.  Google Scholar
  21. Demski, J. S. (1998): Performance measure manipulation. Contemporary Accounting Research, Vol. 15(3), 261–285.  Google Scholar
  22. DuCharme, L. L./Malatesta, P. H./Sefcik, S. E. (2004): Earnings management, stock issues, and shareholder lawsuits. Journal of Financial Economics, Vol. 71(1), 27–49.  Google Scholar
  23. Easterwood, C. M. (1998): Takeovers and incentives for earnings management: an empirical analysis. Journal of Applied Business Research, Vol. 14, 29–48.  Google Scholar
  24. Eddey, P. H./Taylor, S. L. (1999): Directors’ recommendations on takeover bids and the management of earnings: evidence from Australian takeovers. Abacus, Vol. 35(1), 29–45.  Google Scholar
  25. Erickson, M./Wang, S.-W. (1999): Earnings management by acquiring firms in stock for stock mergers. Journal of Accounting and Economics, Vol. 27(2), 149–176.  Google Scholar
  26. Farooqi, J. (2017): Real activities manipulation by bidders prior to mergers and acquisitions. Review of Accounting and Finance, Vol. 16(3), 322–347.  Google Scholar
  27. Friedlan, J. M. (1994): Accounting choices of issuers of initial public offerings. Contemporary Accounting Research, Vol. 11(1), 1–31.  Google Scholar
  28. Gong, G./Louis, H./Sun, A. X. (2008): Earnings management and firm performance following open‐market repurchases. Journal of Finance, Vol. 63(2), 947–986.  Google Scholar
  29. Graham, J. R./Harvey, C. R./Rajgopal, S. (2005): The economic implications of corporate financial reporting. Journal of Accounting and Economics, Vol. 40(1–3), 3–73.  Google Scholar
  30. Guenther, D. A. (1994): Earnings management in response to corporate tax rate changes: Evidence from the 1986 Tax Reform Act. Accounting review, 230–243.  Google Scholar
  31. Hasbrouck, J. (1985): The characteristics of takeover targets q and other measures. Journal of Banking & Finance, Vol. 9(3), 351–362.  Google Scholar
  32. Healy, P. M. (1985): The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics, Vol. 7(1), 85–107.  Google Scholar
  33. Healy, P. M./Wahlen, J. M. (1999): A review of the earnings management literature and its implications for standard setting. Accounting horizons, Vol. 13(4), 365–383.  Google Scholar
  34. Heckman, J. J./Ichimura, H./Todd, P. E. (1997): Matching as an econometric evaluation estimator: Evidence from evaluating a job training programme. Review of Economic Studies, Vol. 64(4), 605–654.  Google Scholar
  35. Hou, Q./Jin, Q./Yang, R./Yuan, H./Zhang, G. (2015). Performance commitments of controlling shareholders and earnings management. Contemporary Accounting Research, Vol. 32(3), 1099–1127.  Google Scholar
  36. Jaggi, B./Lee, P. (2002): Earnings management response to debt covenant violations and debt restructuring. Journal of Accounting, Auditing & Finance, Vol. 17(4), 295–324.  Google Scholar
  37. Jensen, M. C. (1986): Agency costs of free cash flow, corporate finance, and takeovers. American economic review, Vol. 76(2), 323–329.  Google Scholar
  38. Jensen, M. C./Ruback, R. S. (1983): The market for corporate control: The scientific evidence. Journal of Financial Economics, Vol. 11(1–4), 5–50.  Google Scholar
  39. Jones, J. J. (1991): Earnings management during import relief investigations. Journal of Accounting Research, Vol. 29(2), 193–228.  Google Scholar
  40. Keating, A. S./Zimmerman, J. L. (1999): Depreciation-policy changes: tax, earnings management, and investment opportunity incentives. Journal of Accounting and Economics, Vol. 28(3), 359–389.  Google Scholar
  41. Kennedy, V. A./Limmack, R. J. (1996): Takeover activity, CEO turnover, and the Market for Corporate Control. Journal of Business Finance & Accounting, Vol. 23(2), 267–285.  Google Scholar
  42. Kothari, S. P./Leone, A. J./Wasley, C. E. (2005): Performance matched discretionary accrual measures. Journal of Accounting and Economics, Vol. 39(1), 163–197.  Google Scholar
  43. Lehn, K./Poulsen, A. (1989): Free Cash Flow and Stockholder Gains in Going Private Transactions. Journal of Finance, Vol. 44(3), 771–787.  Google Scholar
  44. Lemmon, M./Roberts, M. R. (2010): The response of corporate financing and investment to changes in the supply of credit. Journal of financial and quantitative analysis, Vol. 45(3), 555–587.  Google Scholar
  45. Liberty, S. E./Zimmerman, J. L. (1986): Labor Union Contract Negotiations and Accounting Choices. The Accounting Review, Vol. 61(4), 692–712.  Google Scholar
  46. Louis, H. (2004): Earnings management and the market performance of acquiring firms. Journal of Financial Economics, Vol. 74(1), 121–148.  Google Scholar
  47. Louis, H./Robinson, D. (2005): Do managers credibly use accruals to signal private information? Evidence from the pricing of discretionary accruals around stock splits. Journal of Accounting and Economics, Vol. 39(2), 361–380.  Google Scholar
  48. Moeller, S. B./Schlingemann, F. P./Stulz, R. M. (2004): Firm size and the gains from acquisitions. Journal of Financial Economics, Vol. 73(2), 201–228.  Google Scholar
  49. Mughal, A./Tao, Q./Sun, Y./Xiang, X. (2021): Earnings management at target firms and the acquirers’ performance. International Review of Economics & Finance, Vol. 72, 384–404.  Google Scholar
  50. Palepu, K. G. (1986): Predicting takeover targets: A methodological and empirical analysis. Journal of Accounting and Economics, Vol. 8(1), 3–35.  Google Scholar
  51. Park, Y. W./Shin, H.-H. (2004): Board composition and earnings management in Canada. Journal of Corporate Finance, Vol. 10(3), 431–457.  Google Scholar
  52. Pincus, M./Rajgopal, S./Venkatachalam, M. (2007): The accrual anomaly: International evidence. The Accounting Review, Vol. 82(1), 169–203.  Google Scholar
  53. Powell, R. G. (1997): Modelling Takeover Likelihood. Journal of Business Finance & Accounting, Vol. 24(7‐8), 1009–1030.  Google Scholar
  54. Powell, R. G. (2001): Takeover Prediction and Portfolio Performance: A Note. Journal of Business Finance & Accounting, Vol. 28(7‐8), 993–1011.  Google Scholar
  55. Rosenbaum, P. R./Rubin, D. B. (1983): The central role of the propensity score in observational studies for causal effects. Biometrika, Vol. 70(1), 41–55.  Google Scholar
  56. Rosenbaum, P. R./Rubin, D. B. (1985): Constructing a control group using multivariate matched sampling methods that incorporate the propensity score. American Statistician, Vol. 39(1), 33–38.  Google Scholar
  57. Roychowdhury, S. (2006): Earnings management through real activities manipulation. Journal of Accounting and Economics, Vol. 42(3), 335–370.  Google Scholar
  58. Schipper, K. (1989): Commentary on earnings management. Accounting horizons, Vol. 3(4), 91–102.  Google Scholar
  59. Servaes, H. (1991): Tobin’s Q and the Gains from Takeovers. The Journal of Finance, Vol. 46(1), 409–419.  Google Scholar
  60. Shivakumar, L. (2000): Do firms mislead investors by overstating earnings around seasoned equity offerings? Journal of Accounting and Economics, Vol. 29, 339–371.  Google Scholar
  61. Shleifer, A./Vishny, R. W. (2003): Stock market driven acquisitions. Journal of Financial Economics, Vol. 70(3), 295–311.  Google Scholar
  62. Skinner, D. J./Sloan, R. G. (2002): Earnings surprises, growth expectations, and stock returns or don’t let an earnings torpedo sink your portfolio. Review of Accounting Studies, Vol. 7(2–3), 289–312.  Google Scholar
  63. Sloan, R. (1996): Do stock prices fully reflect information in accruals and cash flows about future earnings?(Digest summary). Accounting review, Vol. 71(3), 289–315.  Google Scholar
  64. Subramanyam, K. (1996): The pricing of discretionary accruals. Journal of Accounting and Economics, Vol. 22(1–3), 249–281.  Google Scholar
  65. Tao, Q./Liu, M./Hu, S./Zhang, Y. (2021): Is a promise a promise? Analyzing performance commitment in acquisitions and target firm performance. The European Journal of Finance, 1–27.  Google Scholar
  66. Teoh, S. H./Welch, I./Wong, T. J. (1998a): Earnings management and the underperformance of seasoned equity offerings. Journal of Financial Economics, Vol. 50(1), 63–99.  Google Scholar
  67. Teoh, S. H./Welch, I./Wong, T. J. (1998b): Earnings Management and the Long-Run Market Performance of Initial Public Offerings. Journal of Finance, Vol. 53(6), 1935–1974.  Google Scholar
  68. Xie, H. (2001): The mispricing of abnormal accruals. The Accounting Review, Vol. 76(3), 357–373.  Google Scholar
  69. Xu, R. Z./Lacina, M. J. (2009): Explaining the accrual anomaly by market expectations of future returns and earnings. Advances in Accounting, Vol. 25(2), 190–199.  Google Scholar
  70. Zang, A. Y. (2012): Evidence on the Trade-Off between Real Activities Manipulation and Accrual-Based Earnings Management. Accounting review, Vol. 87(2), 675–703.  Google Scholar

Abstract

This study tests the hypothesis that the target firms are involved in earnings management activities in quarters leading to a takeover announcement. Using a sample of 3,455 Chinese listed firms that are targets of successful acquisitions over the period 2007–2020, and for a matched sample of non-targets, we find that target firms manipulate earnings in quarters leading to the announcement date. Further, we find evidence of a negative relationship between earnings management and short-term gains to shareholders. Our result remains robust after controlling for various deal characteristics. The study also suggests that pre-merger earnings management in target firms is not fully anticipated by the market before the takeover announcement. We find no evidence of earnings management immediately after the announcement quarter.