Abstract

This research explores earnings quality as a quality measurement of optimism and trust in future returns, where the highly sustainable business has driven up obedience and compliance as a sign of prudent and consistent accounting policy. Manipulation activity is a widely open chance for opportunistic motives, associated with low certainty as a handicap to estimate high accuracy future returns. All observations in the Indonesia-listed manufacturing companies occurred from 2010 to 2022; this causal research uses moderated regression with the dummy variable in testing hypotheses and robust checks. This purposive sampling research has 154 companies with an unbalanced panel; two testing models on equity and earnings are used as sensitivity testing of positive perception. The high-prospected firm pointed out the persistent willingness to implement positive earnings management with this high consistency accounting treatment, which has been transformed into no violation. A positive correlation exists between high earnings quality and future returns, including concentration on real earnings as symbolized by a rational decision model. High-quality accounting information is valid information in predicting the going concerned, linked up to anticipating the peach-lemon effect, where business growth and dividends are used as a signaling effect. This centralized one-platform of the financial reporting system and going private is aimed to minimize the chance of misleading information and anticipate the low-prospected. The highly prospective has high consistency accounting treatment and proper tax management as the validated sustainability indicator, and the rationality modeling is modified from the simplex-linear programming as simulative modeling concerning the Decision Tree and Bayes Theorems.

Introduction

As proven by some empirical research last decade, high-quality financial reporting has been a crucial prerequisite for investors to monitor and check the capability of management to reach better prospects. The decision usefulness of accounting information is meaningful information because of the high obedience to the regulation (i.e., González-Sánchez et al., 2023; Jian et al., 2023). Structural knowledge of real earnings has recognized that consistency and prudent accounting have connected constructively with the market price movement; inevitably, this adverse signal pointed to a low probability of reaching a highly sustainable business model (i.e., Rezaee and Tuo, 2019; Park et al., 2021). Ping (2016) accentuated that low accruals positively impact investor perceptions with no chance of abnormal returns as a dysfunctional function. Therefore, earnings quality exists as a high–accuracy guideline of optimism and confidence as a decisive standpoint in calculating the expected returns when the volatile movement of agency cost has been a destructive consequence of sustainable performance; subsequently, this pragmatic evidence is reinforced by Akbari et al. (2019), Uzezi (2022), Beardsley et al., (2023), and Al-Asfour and Abu Saleem (2023)), underlining the proper tax management has been prioritized for keeping on the investor’s faith and belief.

The dividend is a “puzzle”, reflecting a myopia perspective of designing this payout policy as optimism of future growth opportunities (i.e., He et al., 2017; Alghazali et al., 2023; Sikalidis et al., 2023), Sidhu et al. (2023) found this payout policy measures the managerial capability of keeping on the business sustainability, particularly in anticipating the financial distress. The prominent role of the signaling effect is to smooth the unpredictable movement of market price, signifying the high risk; this research found a classic phenomenon of high-yielded dividend policy as a gap of research, where the annual average dividend payout ratio is higher than sales and earnings growth. In practice, the pattern of this payout policy has been explored in the Indonesia Capital Market, considering the magnificent performance as number 4 worldwide and the highest index growth in the Southeast Asia region area; accurately, the representative data distribution can be used to generalize the current circumstances of the signaling effect (see Appendix 1 Table 6). Concerning the manufacturing industry sector as an ultimate attractiveness in this capital market (see Appendix 1 Table 7), this sector had extraordinary growth during the Pandemic, representing an irrecusable occurrence. An annually detailed average comparison between the dividend payout and the business growth of sales and earnings is depicted in Fig. 1 below.

Conclusion

These results can be concluded; firstly, earnings quality had tested positively on investor perception when it covered up obedience and compliance. Manipulation activity and tax management are critical P(MAQ, H|DTAQ.Hi)x P(MAQ, H) P(MAQ, H|DTAQ, Hi)x P(MAQ, H) + P(MAQ, H |DTAQ, Lo).x P(DTAQ, Lo) M. Siladjaja and J. Jasman Journal of Open Innovation: Technology, Market, and Complexity 10 (2024) 100191 10 measurable factors in predicting high future certainty; the prudent accounting treatment reflects high consistency in publishing high earnings quality. Secondly, the dividend is used as the most effective signaling effect, which affects earnings quality differently; the positive contribution to earnings quality is a guideline for efficient contracting. Conversely, tax management and dividends have been connected to an exclusively mutual relationship aimed at smoothing the internal conflict intensity; nearly, the management is concerned with the dividend in obtaining a low cost of capital as an absolute comparative advantage. The high sales growth is an indicator of going concern, which is tested to drive up higher obedience and compliance; the high-prospected firm is assured of a highly sustainable business model, including high compliance with a minimum chance of agency costs and tax exposure. Finally, the high rationality perspective illustrated the conceivably interactive feedback between management and investors in predicting each party’s decision precisely as a comprehensive illustration of positive earnings management as optimism and confidence in the future.

The pattern of earnings management has various methods for calculating the residual error as a predictive signal of obedience and compliance because running fair value measurement is acknowledged internationally as a principal-ruled accounting standard. Commonly, the same perception of accounting treatment can be formed worldwide. The testing on the manufacturing-industry sector shows the practical implication for all regulators who must continuously monitor the business sustainability regarding the trust in this capital market. Implicitly, this calculation model can be implemented in other countries when earnings management has been tested as an open chance of discretionary behavior in reporting the actual performance; both consequences of efficient contracting and opportunity motives as a leading role of signaling effect have a critical influence on illustrating the real earnings management, covering up obedience to accounting standards and compliance with tax regulation. When the prospect theory pushes the positive contribution on the expected future returns, it is a challenge for this research to prove this theory; hence, this predictive simulation has been proposed with simplex-linear programming in calculating the maximum returns and minimum cost,

Abstract

We examine auditor responses to the voluntary resignation of independent directors. We show that auditors respond by increasing audit fees or rescinding engagement with their clients, but not by increasing their audit effort. Mechanism tests reveal that independent directors’ voluntary resignation leads to increased regulatory sanctions and negative media coverage, these relationships are more pronounced after the New Securities Law. Auditor response strategies follow an order of priority: at an acceptable level of perceived risk, auditors increase audit fees; when perceived risk exceeds this level, auditors will discontinue the client relationship. Auditors associate greater risk with firms that have (vs. have not) experienced consecutive voluntary resignations by independent directors. Mandatory resignation has no such effect.

Introduction

The board of directors plays a crucial role in corporate governance. The proportion of independent directors on the board is an important metric of the effectiveness of board supervision, which is emphasized by regulatory authorities (Zhu et al., 2016). The independent director system was initially established to mitigate agency problems between shareholders and management (Fama and Jensen, 1983, Dai et al., 2014). Independent directors also supervise, advise and provide support in the form of resources for listed companies (Fama and Jensen, 1983, Liu et al., 2018a, Liu et al., 2018b, Zhou et al., 2021). What signals are sent by the voluntary resignation events of independent directors? Can auditors identify the risks involved? How do auditors respond? We explore this series of questions.

Typically, the resignation events of independent directors are categorized as mandatory or voluntary. Mandatory resignation occurs when independent directors are required to step down from their roles under regulatory pressure; voluntary resignation occurs when independent directors proactively relinquish their positions, judging that the benefits of those positions do not compensate for the risks incurred. According to signaling theory, the voluntary resignation of independent directors signals company risk to external parties (Gupta and Fields, 2009, Lin et al., 2012, Bar-Hava et al., 2021, Cao et al., 2023), such as poor company performance (Arthaud-Day et al., 2006), high levels of earnings management (Zhi and Tong, 2005) or elevated legal risks (Yang and Huang, 2015). This paper focuses on the responses of auditors, as stakeholders in listed companies, to the voluntary resignation of independent directors.

Conclusion

This paper presents an in-depth exploration of auditors’ responses to the voluntary resignation of independent directors. The findings reveal that the voluntary resignation of independent directors of a listed company transmits risk signals to auditors that elevate their perception of the risk associated with that company. In response, auditors seek to mitigate this risk by charging higher audit fees or terminating their engagement with the client company. Interestingly, we find no evidence that auditors also increase their audit effort following the voluntary resignation of independent directors, indicating that the higher audit fees charged are due primarily to an increased risk premium, rather than to cost compensation. Mechanism analysis indicates that companies with voluntary resignations by independent directors face an increased risk of regulatory penalties in both the current and subsequent periods, and such companies also receive more negative media coverage.

Further analysis reveals that since the implementation of the New Securities Law, the positive relationship between the voluntary resignation of independent directors and abnormal audit fees has become more pronounced. This suggests that the new law has a deterrent effect on auditors, increasing their perception of risk and leading them to raise audit fees. Moreover, we discover that auditors follow an order of priority in responding to the risk signals conveyed by the voluntary resignation of independent directors: when they perceive the level of corporate risk to be acceptable, they prefer to increase audit fees, but when the risk exceeds their tolerance level, they are likely to terminate the engagement, leading to an auditor change.

Abstract

The purpose of this research is to examine the effect of voluntary integrated reporting on information asymmetry in European and Asian firms and investigate size as a moderator variable to this relationship. Using a final sample of 94 firms in Europe and Asia that published integrated reports in 2016, the Ordinary Least Square is then performed to analyze the data on quarterly basis. The quarterly analysis is used to look at the relevance of accounting information decline as the time lag increases. The results show that there is an insignificant relationship between integrated reporting quality and information asymmetry which is captured by spread. In addition, the insignificant effect of size to moderate this relationship is also found. These results are supported by additional analysis. This research contributes to the existing debate about whether integrated reporting affects the market, particularly information asymmetry. To the best of the authors’ knowledge, this is the first study to examine the effect of integrated reporting quality on the market on a quarterly basis.

Introduction

Integrated reporting (IR) in recent years has received great public attention particularly after the formation of the International Integrated Reporting Council (IIRC) and the issuance of IR iguidelines (Adams, 2017; Zhou et al., 2017). Despite the critique arising that IR could be yet the tool for corporate impression (Melloni et al., 2017), the IIRC (2013, p. 3) stated that IR can improve “the quality of information available to providers of financial capital to enable a more efficient and productive allocation of capital.” Integrated reporting aims to reduce the clutter of sustainability report by disclosing aspects they consider to be material and useful about the value-creating activities in the short, medium, and long-term into a concise and coherent report (Zhou et al., 2017; IIRC, 2013). Integrated reporting offers a broader picture of the new firm by shifting away from standalone sustainability or social responsibility reports towards an integrated report that delivers a comprehensive picture of long-term performance from various perspectives, business model, and value creation (Burke and Clark, 2016). Hence, the voluntary information disclosure is a way to mitigate the information asymmetry problem and lead to better business transparency (Brammer and Pavelin, 2006).

Nevertheless, empirical evidence on the IR benefit is still sparse (De Villiers et al., 2014). Previous studies conducted by Zhou et al. (2017) and Vitolla et al. (2020) found an inverse relationship between alignment of integrated reports and information asymmetry, measured by analysts’ forecast errors, as well as cost of equity capital. Other studies conducted by Maria et al. (2017), Akker (2017), Martinez, 2016a, Martinez, 2016b, Lee and Yeo (2015) found that IR offers more relevant information. Thus the alignment of corporate reporting with the integrated report is negatively associated with the asymmetric information. Barth et al. (2001) also suggested the evidence that IR quality reduces information asymmetry as captured in a lower bid-ask spread. On the contrary, Stubbs and Higgins (2014) found evidence that IR did not affect a decrease of the level of information asymmetry. They argued that the information provided is not required by the capital providers to make the investment decisions. Accordingly, the limited evidence and inconsistent results found about the market responds to the information available in the integrated reports (Mervelskemper and Streit, 2016).

Conclusions

This research examined the existence of a negative relationship between voluntary integrated reporting and information asymmetry for 94 firms in Europe and Asia in 2017 with publishing an integrated report in 2016. The results show that there is an insignificant relationship between the integrated reporting quality and information asymmetry which is captured by the spread. There is no significant effect as well for size effect to moderate the relationship between the integrated reporting quality and information asymmetry. Those results are also supported by additional analyses.

These findings could be relevant for some aspects of the literature especially in the research design where this study used a continuous variable based on detailed content analysis instead of a dummy variable to measure the integrated reporting quality. Other innovations of this study are that it investigated the IR effect on a quarterly instead of an annual basis. From a practical perspective, as the significant effects are not yet observed, this result can provide the companies with insight on whether to implement the integrated reporting immediately or not. Investors who are interested in the integrated reporting also can consider this finding in their decision making. Finally, the IIRC as the regulator body can conduct some improvements to see how the integrated reporting is proceeding, particularly in the voluntary context. As the IR concept is relatively a new area for corporate reporting in the world, the governments are given the consideration and insight as well whether to encourage the companies in their countries to adopt this trend immediately or not.

Abstract

This study investigates how voluntary International Financial Reporting Standards (IFRS) adoption impacts information asymmetry in the stock market. We analyze data from firms in Japan, where local accounting standards have substantially converged with IFRS but are more rules-based than principles-based IFRS. These different implementation approaches allow us to investigate how increased accounting flexibility influences recognition and measurement practices, attenuating the effects of accounting standard differences on the level of accounting rule existence or non-existence. We find that information asymmetry increases after voluntary IFRS adoption, which is driven by small- and medium-sized IFRS adopters’ decrease in earnings quality after voluntary IFRS adoption. Additional analyses reveal that firms’ reporting incentives and accounting resources influence these changes. These results suggest that IFRS’s increased accounting flexibility in recognition and measurement practices worsens the information environments of firms with weak incentives to commit to transparent financial reporting or fewer accounting resources (i.e., small- and medium-sized firms).

Introduction

As International Financial Reporting Standards (IFRS) are intended to provide investors with information that enables them to make better investment decisions, information asymmetry in stock markets is a critical potential consequence of IFRS adoption. IFRS adoption worldwide is either voluntary or mandatory. Since the 2005 mandatory adoption for firms listed in EU countries, extensive research has been conducted on the effects of mandatory IFRS adoption. However, voluntary IFRS adoption effects are relatively under-researched, especially in recent years (De George et al., 2016, Leuz and Wysocki, 2016). Understanding the effects of voluntary adoption is also important because a non-trivial number of countries either allow voluntary IFRS adoption or prohibit IFRS adoption (Song and Trimble, 2022). As of 2019, 11 % (22) of 195 countries/territories permit IFRS adoption and 6 % (11) presently prohibit it, although the latter could permit voluntary adoption in the future. This study attempts to further our understanding of how voluntary IFRS adoption affects information asymmetry in stock markets.

Prior research provides mixed evidence on the stock market consequences of voluntary IFRS adoption. Early studies on this topic focus on Germany, where local accounting standards are substantially different from IFRS. These studies provide evidence suggesting that voluntary adopters exhibit lower information asymmetry in the stock market compared to non-adopters (Gassen and Sellhorn, 2006, Leuz and Verrecchia, 2000). However, in international comparisons, Daske et al. (2008) use two proxies for differences between local accounting standards and IFRS and report inconsistent liquidity effect results. Specifically, they observe no change in liquidity after voluntary IFRS adoption in countries with small differences between local generally accepted accounting principles (GAAP) and IFRS, but a decrease in liquidity in countries with IFRS convergence processes. Therefore, how voluntary IFRS adoption affects information asymmetry in stock markets in countries whose accounting standard differences from IFRS are relatively small remains unclear. This study aims to extend this line of research.

Conclusions

Prior research suggests that voluntary IFRS adoption positively affects information asymmetry in stock markets when local accounting standards significantly differ from IFRS and is viewed as a commitment to transparent financial reporting. However, other research obtains inconsistent results for voluntary IFRS adoption effects on information asymmetry in countries with small accounting differences between local standards and IFRS. We looked closer at Japan, where local accounting standards have been converged to IFRS but have a different implementation approach (i.e., small accounting rule differences but large implementation approach differences). We investigated the effect of voluntary IFRS adoption on the stock market (i.e., changes in information asymmetry in the stock market proxied by bid-ask spread) as well as its potential reason (i.e., changes in earnings quality proxied by the absolute value of discretionary accruals). We also examined whether this effect varies according to firm size, which represents firms’ reporting incentives and accounting resources. Our study’s findings and incremental contributions to the literature are as follows.

First, we find an increase in the bid-ask spread after voluntary IFRS adoption. This result suggests that, on average, voluntary IFRS adoption worsens information asymmetry in Japan’s stock markets. Second, we observe deterioration in bid-ask spread only for smalland medium-sized voluntary adopters. Third, we examine changes in IFRS adopters’ earnings quality before and after IFRS adoption to explore a reason for the increased bid-ask spread. We find that small- and medium-sized firms report larger discretionary accruals after voluntary IFRS adoption. These results suggest that the increase in information asymmetry in the stock market results, at least partially, from the decreased earnings quality of small- and medium-sized firms after voluntary IFRS adoption. Finally, we provide some evidence suggesting that firms’ reporting incentives and limited accounting resources deteriorate earnings quality and information asymmetry at the time of voluntary IFRS adoption.

Abstract

This article systematically reviews 94 accounting and finance studies that address the real effects of financial reporting. Whereas the effects of financial reporting on capital suppliers’ decisions traditionally have received much attention, recent research has generated important new insights into the feedback effects of financial reporting on the reporting firms’ real activities (e.g., investments or allocation and use of resources). We identify the consequences of financial reporting for (1) the reporting firm, (2) its peer firms, and (3) the input and output markets. We also highlight the effects of firms’ internal controls over financial reporting and consider how accounting and auditing regulations influence and contribute to real effects. The studies we review are consistent in their findings that high-quality financial reporting is positively associated with the efficiency of the reporting firm’s resource allocation. Many studies also suggest a positive association between high-quality financial reporting and an efficient allocation of resources in the real sector, which can also benefit other market participants like consumers or employees. The article concludes with an outlook on fruitful research opportunities.

Introduction

Most accounting research focuses on the capital market effects of financial reporting. Financial reporting informs investors, creditors, and the public about firms’ activities, net assets, financial position, and results of operations. It thus decreases information frictions when firms need to fund (new) projects and activities. A large portion of the literature on the effects of financial reporting addresses efficiency problems in the capital market by investigating the decisions taken by capital suppliers (e.g., Ball and Sadka, 2015, Ball et al., 2009, Botosan, 2006, Dye and Sridhar, 2002, Verrecchia, 2001). However, the relevance of financial reporting for the real sector, which includes firms’ decisions on investments and the production and consumption of goods and services, has received considerably less attention. Nevertheless, a small but fast-growing strand of the accounting and finance literature investigates the effects of financial reporting on the real sector. These effects are also referred to as real effects.

Most real effects studies investigate the economic effects of financial reporting on the investments and operations of the reporting firm (e.g., Biddle et al., 2009, García Lara et al., 2016, Kanodia and Sapra, 2016, McNichols and Stubben, 2008). An increasing number of studies also address the effects of a firm’s financial reporting on its peer firms. Examples of such studies are Badertscher et al., 2013, Beatty et al., 2013, Durnev and Mangen, 2009, and Li (2016), who find that misreporting can distort the peer firms’ investment and operational efficiency. The reason is that the peers seem to rely on misleading economic prospects. In contrast, peer firms might benefit from learning about market uncertainties from another firm’s financial report (Badertscher et al., 2013, Bernard et al., 2020, Durnev and Mangen, 2020). Finally, a few studies investigate the real effects of finanical reporting for the aggregate input or output market. These studies are consistent in their finding that financial reporting can facilitate the efficient allocation of resources across firms, for example, by reducing differences in productivity within an industry (Breuer, 2021, Francis et al., 2009, Hann et al., 2020). However, there is scarce research on the real consequences of financial reporting for other market participants in the input or output market. Yet real effects for consumers can exist in the output market, if, for example, firms change their pricing policies (Li, 2016, Sadka, 2006) or differentiate their products (Bernard et al., 2020) in response to their competitors’ financial reports. Furthermore, in the labor input market, financial reporting relates to firms’ labor investment efficiency (Choi, 2021, Jung et al., 2014, Kedia and Philippon, 2009), and this ultimately has implications for employees.

Conclusion

This review article summarizes 94 studies on the role of financial reporting for the real sector, focusing on (1) the reporting firm, (2) its peer firms, and (3) the input and output market. First, we find that most of the studies investigate real effects for the reporting firm. The findings of these studies suggest that high-quality financial reporting is positively associated with firms’ investments and operations efficiency. The reporting of (in)efficient internal controls can be interpreted as a moderating factor in firms’ efficiency in real decisions. Second, an increasing number of studies investigate the real effects of financial reporting for the reporting firm’s peers. These studies suggest that high-quality financial reporting can improve the efficiency of peer firms’ real decisions through learning. Low-quality reporting, on the other hand, can be misleading and result in inefficient real decisions by peer firms. Third, we find that only a few studies focus on the real consequences of financial reporting at the aggregate level. The findings suggest a positive association between industry- or country-level measures of financial reporting quality and the efficient allocation of resources across firms (e.g., by increasing product market competition). However, the economic implications of financial reporting for other market participants (e.g., consumers or employees) remain insufficiently explored. For example, consumers might benefit from an increase in product market competition resulting from high-quality financial reporting. Moreover, financial reporting quality positively relates to firms’ labor investment efficiency, which can affect employees. Finally, we observe that an increasing number of studies investigate the real effects of accounting and auditing regulations. These studies suggest that financial reporting regulations addressing the needs of capital market participants can have unintended economic consequences for firms and other market participants in the real sector.

Abstract

We test whether firm sustainability positively affects access to bank credit. We carry out a panel data analysis of 125 listed Italian SMEs across 14 regions over 2017–2021. A quantitative score comprising 20 items grouped into three areas, disclosure, processes, and governance, is computed to determine the level of implementation of sustainable practices of sampled SMEs. Results show that SMEs with more sustainable orientation have greater access to bank credit and better ability to pay the cost of bank debt. This, in turn, reinforces bank-SME relationships. We contribute to the literature on SMEs, highlighting the relationship between sustainability and the availability of bank loans.

Introduction

Starting from the notions of sustainable development in the Brundtland Report published by the World Commission on the Environment in 1987 (WCED, 1987), further attention on sustainability has increased, culminating in several important initiatives such as the Paris Climate Agreements (COP 21) and the 2030 Agenda of the United Nations for Sustainable Development, both adopted in 2015. More recently, specific activities and regulations implemented by the European Union, including the EU Taxonomy and the European Green Deal, provide additional support for the green transition and integration of sustainability into company business models (BIS 2021).

From the perspective of banks, financial regulators are strengthening regulations in an attempt to encourage these institutions to support and promote sustainability practices. Recently banking supervisors have launched important appeals and recommendations to raise awareness on the potential effects of environmental risk, improve the understanding of climate risk measurement issues facing banks and on transitioning to a low-carbon and more circular economy. Specifically, increasing pressure is being exerted on all EU banks to integrate sustainability factors into the lending decision-making processes. In turn, increased commitment to climate issues could lead banks to develop a more effective environmental management system and environmental credit risk management which mediates bank riskiness and improves overall financial stability (EBA – European Banking Authority, 2020a, EBA – European Banking Authority, 2020b).

Conclusions, implications and future research lines

The ‘sustainability challenge’ represents a global issue that affects all companies, whether financial or non-financial, especially following the Covid-19 pandemic. Falling behind in this process of adaptation not only means losing a competitive advantage but also risking being pushed out of the marketplace altogether. This is true for banks, which are now being asked by regulators to rearrange all their main business processes (e.g., strategies, risk management, capital allocation, loan origination and monitoring, disclosure), adapting them to comply with specific ESG sustainability criteria. It is even more true, however, for non-financial firms, especially SMEs. These firms are a pillar of the European economy and a central player in value chains and community dynamics (Beck, 2013; Gomes and Pinho, 2023; Angilella and Mazzù, 2015). Thus, involving them in the sustainability process is vital to ensuring the success of the transition to sustainability in Europe. In addition, for SMEs, being included in the sustainability agenda is paramount to accessing key resources and opportunities, obtaining better financial conditions and entering into important partnerships (European Investment Bank-EIB, 2023).

Scholars have revealed that an increasing number of banks are starting to include ESG factors in their lending decisions (Scholtens, 2009, Goss and Roberts, 2011). Many financial intermediaries, facing the threats generated by ESG risks, tend to prefer lending to businesses that are more sustainable and, therefore, less risky (Weber, 2012). Academic research shows that this strategy is virtuous because granting credit to more sustainable companies creates value for banks in terms of a higher net interest margin and a reduction in default risk (Mirza et al., 2023). For these reasons, banks are also increasing their share of green operations by offering capital at lower cost to firms more compliant with environment goals (Attig et al., 2013, El Ghoul et al., 2018, Wellalage and Kumar, 2021).

Abstract

Supply chain resilience and the ripple effect have been widely studied, mostly focusing on material flow-related practices. The financial flow adjustments to cope with supply chain disruptions have received much less attention. We contribute to the literature by examining the impact of adapting payment terms during and after disruptions. In particular, we perform a discrete event simulation analysis in anyLogistix for a complex supply chain network to investigate the impact of adjusting payment terms on supply chain cash flows. Our results suggest that collaboratively adjusting payment terms is an effective strategy for coping with disruptions. In contrast, ad hoc adjustments and immediate returns to pre-disruption payment schemes do not yield visible improvements. Positive effects on cash and loans are observed if an adjustment of payment terms occurs proactively and in a coordinated manner, especially when expediting payments downstream and payment slowing down upstream. The results from our sensitivity analysis on the impact of accelerating/decelerating cash conversion cycles favour shorter cycles when coping with disruptions. We deduce useful managerial insights and reveal some new theoretical tensions related to the impact of payment adjustments on cash flows in supply chains.

Introduction

Supply chain resilience and the ripple effect have been significantly visible research avenues ( Chervenkova and Ivanov, 2023 , Dolgui et al., 2023 , Sawik, 2023 , Ivanov, 2024a , Ivanov, 2024b ). The extant literature offers numerous strategies and practices for the preparedness and recovery of supply chains ( Hosseini et al., 2019 , Ivanov and Dolgui, 2021 , Ivanov et al., 2021 , Gruchmann et al., 2024 ). Most of these strategies and practices are related to material flows – e.g. backup suppliers, risk mitigation inventory, and capacity flexibility ( Lin et al., 2021 , Mitręga and Choi, 2021 , Brusset et al., 2023 , Hägele et al., 2023 , Aldrighetti et al., 2024 ). Some research examined the role of information flows in supply chain resilience, focusing on visibility, digital technology, and cybersecurity ( Ivanov, 2021 , Sawik, 2022 , Dubey et al., 2023 ). However, practices of financial flow adjustments to cope with supply chain disruptions have received much less attention ( Choi et al., 2023 ).

The role of financial flows in supply chain resilience is a distinct but underexplored topic of high practical relevance. Consider an example. In the fall of 2023, Ford’s supply chain experienced a series of disruptions caused by strikes ( Shepardson and White, 2023 ). Assembly plants stopped, leading to significant monetary losses at Ford ($1.7 billion in lost profits and about 100,000 units fewer wholesale vehicle sales from the strike) ( Gomes, 2023 ). Adversely, the ripple effect from the disruptions at the assembly plants could have resulted in setting Tier 2 suppliers at financial risk and danger of bankruptcy because of missing liquidity, higher interest rates, and difficulties to get loans from the banks ( Vicci, 2023 ).

Conclusion

In this study, we departed from the existing research gap about the role of cash flows in supply chain resilience and ripple effect analysis. The extant literature mostly focuses on strategies for preparedness and recovery related to material flows. Practices of financial flow adjustments to cope with supply chain disruptions have received much less attention. However, the practical and academic importance of this topic are unquestionable.

The main contribution of our study to the literature is an examination of the impacts of payment term adaptation during and after disruption responses, along with proposing useful coping strategies based on adjusting deferment periods and the role of coordination in this adaptation. The objective of our analysis was to investigate the impact of adjusting payment terms on supply chain cash flows.

Methodologically, we utilised a discrete event simulation analysis in anyLogistix applied to a complex supply chain network. We performed simulations with nominal (disruption-free) and disruption scenarios considering different response strategies. The computational results of this study have been translated into useful managerial insights on the importance of payment term adjustment during disruptions to avoid bankruptcies in the supply chain and improve its resilience.

Abstract

Audit practice is a team effort led by signing auditors. We examine the impact of the heterogeneity of signing auditors’ audit-firm serving experiences on the disclosure of key audit matters (KAMs). Auditors with more heterogeneous serving experiences demonstrate more adequate KAM disclosure, as evidenced by more KAMs, longer texts and clearer attributions in their disclosures. This effect is influenced by the quality of audit knowledge that auditors accumulate from different serving experiences and the team- and audit-firm-level knowledge integration environment. Furthermore, signing auditors with more diverse service experience tend to improve audit quality, reduce the incidence of restatement or misconduct and enhance the informativeness of financial reports. Our findings enrich the KAM disclosure research and provide insights into audit firms’ human resource allocation and internal management.

Introduction

In 2016, China’s Ministry of Finance mandated new audit report standards, introducing Key Audit Matters sections in listed companies’ audit reports to bolster transparency and highlight financial statement risks through auditors’ judgment ( Chen et al., 2021 ). Studying the disclosure of key audit matters (KAMs) is pivotal for enriching the content of audit report information and nurturing capital market health ( Reid et al., 2015 , Wang et al., 2018 , Li et al., 2019 ). Research predominantly examines the economic consequences of KAM disclosure ( Wang and Li, 2019 , Liu and Lei, 2020 , Zhou et al., 2020b ). Only a few studies investigate the determinants of KAM disclosure, with major focuses on client characteristics ( Pinto and Morais, 2019 ; Li et al., 2020; Qian et al., 2022 ), individual auditor attributes ( Cao, 2021 , Chen et al., 2021 ), client–auditor relationships ( Hu and Hu, 2021 ) and abnormal audit fees ( Chen et al., 2022 ). Audit practice is inherently team work, with the leading signing auditors critically influencing team efficiency ( Jiang and Tang, 2016 , Yan et al., 2017 ). In the context of integrated management within accounting firms, exploring effective personnel allocation for audit teams is important for promoting the integration of internal resources within organizations and driving the audit market toward intrinsic, high-quality development. We investigate how the heterogeneity of signing auditors’ audit-firm serving experience affects KAM disclosure from a team theory perspective. 1

Auditing is a profession characterized by a relatively high turnover rate, with auditors often transitioning between audit firms ( Hermanson et al., 2016 ). For instance, the Shanghai Institute of Certified Public Accountants announced that in September 2022, 122 certified public accountants in Shanghai handled issues related to transferring to other firms. The professional experiences gained in various firms have a profound impact on individual auditors’ knowledge acquisition and cognitive processes ( Che et al., 2020 , Tian et al., 2021 ). Furthermore, the diversity in the audit-firm serving experiences of signing auditor pairs may influence their knowledge integration, which has implications for their audit judgments ( Carpenter, 2007 , Bonner et al., 2022 ).

Conclusions

In this study, we provide novel empirical evidence on the factors influencing KAM disclosure. We find that signing auditors with more heterogeneous audit-firm serving experiences exhibit more adequate KAM disclosure. Mechanism analysis reveals that the quality of knowledge accumulated from heterogeneous serving experiences and the knowledge integration environment at both the team and firm levels significantly influence the impact of serving experience heterogeneity. Specifically, the increase in KAM disclosure adequacy is more salient when auditors accumulate higher-quality knowledge through heterogeneous serving experiences, when audit teams exhibit educational gaps between members, when review partners have heterogeneous experiences and when audit firms are smaller. Economic consequence tests indicate that signing auditors with greater serving experience heterogeneity can enhance audit quality through more audit input, significantly reduce the probability of restatements and financial misconducts and ultimately enhance the informativeness of accounting information. In other words, such audit teams can improve accounting information quality by thoroughly identifying and addressing potential risks in financial reporting.

We extend the literature on KAM disclosure through a novel investigation of how audit team composition affects the adequacy of such disclosure. Our findings offer valuable implications for practice. In the realm of integrated audit firm management, human resource management is pivotal for audit firms’ internal governance. Managers need to consider the proper allocation of human resources from the perspective of auditor team composition. By leveraging differentiated serving experiences within audit teams, they can adjust member configurations, enhance communication and cooperation among team members, better harness their teams’ collective intelligence and improve internal governance mechanisms and quality management systems. Regulatory bodies are encouraged to encourage audit teams to embrace diverse decision-making frameworks. This shift will aid audit firms in transitioning from a growth-centric to a strength-based approach and promote the healthy development of capital markets.

Abstract

This research contributes to understanding the spillover effect of customer digital transformation along the supply chain. We take a supply chain relationship perspective to explore the influence of customers’ digital transformation on suppliers’ audit fees and find a significant reduction in such fees when customers undergo digital transformation. An economic mechanism analysis reveals that this transformation reduces audit fees by lowering the risks and costs encountered by auditors. This is achieved by mitigating suppliers’ business risks and improving earnings quality. Heterogeneity analysis reveals that the impact of customers’ digital transformation on suppliers’ audit fees is more pronounced when the supply chain is geographically distant, suppliers with more specific investments and with high levels of market competition.

Introduction

Digital transformation involves shifting from a traditional “industrialized” management model to a digital management model ( Verhoef et al., 2021 ). This transition goes beyond simply applying digital technologies to technical aspects of a business and involves a complete restructuring of business models and operational management. Research on the economic consequences of digital transformation emphasizes its potential influence on the quality of corporate disclosures and business risks. For example, digital technologies can improve operational management, promote networked and flattened organizational structures ( Nambisan et al., 2019 ), increase corporate disclosure transparency and the quality of accounting information and enhance communication, production and operational efficiency ( Wu et al., 2021 , Chen et al., 2022a ). By digitally collecting and analyzing data, firms can effectively visualize information, enhance interdepartmental coordination, refine risk control processes, mitigate operational risks and reduce management fraud and decision-making errors that lead to losses, thereby enhancing their market reputation ( Manita et al., 2020 , Zhou and Li, 2023 ). Most studies focus on the direct effects of digital transformation on firms’ risk responses and information transfer capabilities, while its broader effects on the supply chain have not been sufficiently investigated ( Guo et al., 2023 ).

The production operations of suppliers and their financial decisions are influenced and informed by their customers, who therefore play a vital role in the supply chain ( Ak and Patatoukas, 2016 ). Investing in supply chain relationships promotes the economic interdependence of suppliers and customers. The value of such investment depends on customers’ growth prospects, and ensuring the stability of their businesses can lead to higher expected returns from supply chain collaboration. Conversely, if customers face business challenges or go bankrupt, they can jeopardize the value of the assets allocated by suppliers ( Raman and Shahrur, 2008 ). This increases suppliers’ cash flow and operational risk ( Itzkowitz, 2013 ). Thus, suppliers are highly sensitive to the operations and activities of their customers. The risks and information associated with customers can generate a spillover effect in the supply chain, which can then trigger cascading changes in suppliers’ operational risks and influence their investments and financial decisions ( Hertzel et al., 2008 , Jacobson and von Schedvin, 2015 , Chiu et al., 2019 ). By gaining access to more transparent customer information, suppliers can better forecast customer demand, reduce transaction costs, alleviate shortages and losses and enhance production efficiency and inventory management ( Yang et al., 2020 ). Digital transformation can have positive effects on business risks and disclosure quality, in addition to the supply chain, but does the digital transformation of customer businesses also lead to additional spillover effects on suppliers?

Conclusion and discussion

Amid increased economic uncertainty, businesses are increasingly turning to digital transformation to enhance their resilience and optimize their resource allocation. The supply chain is a critical component of business operations that integrates logistics, information flow and capital flow. Microenterprises aiming to gain a competitive advantage can enhance their collaborations within supply chains. We investigated the spillover effect of customer digital transformation on suppliers through assessing its impact on audit fees. This extends research on the economic consequences of digital transformation beyond the boundaries of supply chain relationships. Our empirical findings indicate that customers’ digital transformation can reduce suppliers’ audit fees. Our heterogeneity analysis shows that this effect is more evident when there is a greater geographic distance between suppliers and customers, higher levels of dedicated investment and increased competitiveness in the supplier market. Through the economic mechanism of mitigating supply chain risk and facilitating collaboration and information transfer in supply chains, customers’ digital transformation reduces suppliers’ audit risks and costs, thus leading to lower audit fees.

Based on previous research findings, we offer the following conclusions. First, the implementation of digital transformation by suppliers’ customers can potentially cause a spillover effect across the supply chain, thereby affecting the economic interests and decisions of suppliers. Consequently, when faced with fierce market competition, firms should fully realize the beneficial effects of digital transformation on information transfer efficiency and collaboration within the supply chain. Such transformation should therefore be actively promoted, because through it firms can facilitate a seamless connection of resources, information and knowledge within the supply chain, thus fostering sustainable economic growth through enhanced coordination and cooperation.

Abstract

This paper delves into the integration of Intelligent Process Automation within the domain of business continuity auditing, with a focus on the Portuguese banking sector. In an era marked by rapid technological advancement, organizations are increasingly leveraging automation to reinforce operational efficiency and realize substantial cost savings. Concurrently, auditors play a pivotal role in ensuring seamless transitions amid technological transformations to safeguard business continuity. This research endeavors to bridge the realms of business continuity and intelligent automation, culminating in a comprehensive application that streamlines the audit process. The implemented solution encompasses the automation of critical audit activities, including communication, information requests, and final report submissions, liberating auditors from the chains of repetitive tasks. The incorporation of business intelligence augments this automation framework, enabling a meticulous analysis of key performance indicators within the audit department. This ensures a continuous evaluation of the efficacy of the Annual Audit Plan. Empirical validation of this initiative was achieved through surveys conducted with audit teams from four prominent Portuguese banks. The results unequivocally affirm the potential benefits of this implementation, extending invaluable support to management in the decision-making process, while concurrently alleviating auditors of routine tasks inherent to the audit process. This study not only underscores the transformative potential of intelligent process automation in the audit domain but also offers a replicable framework for organizations seeking to fortify their business continuity efforts through technological integration. The findings hold implications for businesses navigating the dynamic intersection of technology and audit practices, providing a blueprint for harnessing automation for enhanced operational resilience.

Introduction

Technological advancements have greatly increased information accessibility and are continuously reshaping information systems to meet future demands This dynamic environment compels organizations to adopt open innovation strategies to streamline operations, enhance efficiencies, and fortify fraud prevention measures. The COVID-19 pandemic has accelerated the shift towards remote work, emphasizing the importance of process automation. In auditing, technology has become essential in ensuring compliance, assessing risks, and improving operational efficiencies, promoting transparency and accountability. The shift from manual to automated and continuous auditing is driven by emerging technologies like Artificial Intelligence (AI) and blockchain, significantly affecting the banking sector. Despite these advances, the transition to fully digital auditing practices remains gradual, with many institutions still reliant on traditional methods.

The auditing process has evolved from traditional manual audits of paper documentation to computer-based auditing, progressing towards a paperless, electronic, real-time continuous auditing environment ( Rezaee et al., 2002 ). The banking sector has faced numerous challenges in recent years, responding to incentives and imperatives related to technological advances, market volatility, and increasing regulatory and public scrutiny. Since the 2007 financial crisis, known as the subprime crisis, the audit function in banking institutions has become significantly more crucial. Its primary mission is to mitigate the risk of potential or actual losses, thereby enhancing the institution’s risk profile ( Zinca, 2016 ). Internal Audit (IA) departments are under increasing pressure to leverage technology for automating the identification of exceptions and/or anomalies and for control testing ( The Institute of Internal Auditors, 2019 ).

Conclusions

This study aimed to integrate automation within the audit process, thereby streamlining manual and repetitive tasks to enhance the efficacy of business continuity management. This goal was pursued through the identification of optimal automation solutions and the mitigation of associated risks.

A multi-stage methodological approach was utilized, beginning with an extensive literature review to identify the risks, benefits, and challenges linked with the automation of audit processes. This was followed by the application of the DSRM to precisely define the core problem and develop an appropriate solution. Subsequent phases involved the detailed design and development of the proposed solution, culminating in a survey conducted among bank auditors to evaluate how well the solution met their needs.

The findings from this study highlight the pivotal role of IPA in the audit process. Significant advantages were observed, including the implementation of an alert system that notifies auditors of upcoming audits and the use of KPIs to provide a detailed overview of the progress within the audit plan. These tools help identify areas that require refinement in audit management.

This paper investigates the effect of brand capital on firms’ choices of debt structure. Using a sample of publicly listed U.S. firms between 2001 and 2019, we find that firms with higher levels of brand capital rely less on bank debt financing. This finding is robust to the use of alternative regression models and alternate measures of brand capital and bank debt financing. Employing an industry-level positive shock to brand capital as a quasi-natural experiment, we demonstrate that such a shock negatively affects firms’ reliance on bank debt. Our cross-sectional analyses reveal that the effect of brand capital on bank debt is more pronounced for firms with high information asymmetry, weak corporate governance mechanisms, and poor financial conditions. We also find that brand capital-intensive firms raise funds from the public debt market and issue more (or less) unsecured (or secured) debt. Taken together, we show that brand capital has an important bearing on corporate financing decisions.

Introduction

This study investigates the relationship between brand capital and debt choice. Debt stands as a crucial source of financing for corporations, with U.S.-domiciled firms raising over $2.5 trillion in new debt capital in 2020 alone, comprising bonds, syndicated debt, and various types of loans. In contrast, equity markets saw a mere $335 billion secured during the same period.1 Firms that choose to use debt to finance their projects can borrow from banks or issue debt in the public market, also known as debt choice. Existing literature suggests that corporate debt choice is affected by various factors such as corporate disclosure quality (Dhaliwal, Khurana, & Pereira, 2011), analyst coverage (Li, Lin, & Zhan, 2019), external governance mechanisms (Bharath & Hertzel, 2019), state ownership (Boubakri & Saffar, 2019), product market competition (Boubaker, Saffar, & Sassi, 2018), and corporate ownership and control rights (Lin, Ma, Malatesta, & Xuan, 2013). However, the influence of firm-specific brand capital (i.e., an intangible asset encompassing consumers’ awareness, impressions, loyalty, and recognition of a product, service, or organisation (Belo, Gala, Salomao, & Vitorino, 2022, Belo, Lin, & Vitorino, 2014, Hasan, Taylor, & Richardson, 2022, Pillai, 2012)) on debt choice remains unexplored.2 This study aims to bridge this gap in the literature.

The motivation for this study stems from the growing recognition that brand capital constitutes a sizable share of corporate value. For instance, Belo et al. (2022) show that brand capital accounts for 6%–25% of firms’ market value. The Economist reported that “brands account for more than 30% of the stock market value of companies in the S&P 500 index.”3 Forbes estimated that the top 100 most valuable brands in 2020 were collectively worth $2.5 trillion.4 Notably, financial intermediaries also emphasize the importance of brands, as evidenced by the downgrading of Volkswagen’s credit rating by Fitch Ratings and Standard & Poor’s (S&P) following the 2015 emission crisis. In response to this crisis, Volkswagen had to secure a $21.2 billion bank loan to navigate the challenges, demonstrating the critical role of brand capital in maintaining financial strength and managing reputational damage.5 Against this backdrop, our central research question revolves around the impact of brand capital on firms’ access to public debt and, by extension, its potential to reduce dependence on bank debt. This study aims to empirically address this question, shedding light on a crucial aspect of corporate financing decisions.

Conclusion

Using a large sample of publicly listed U.S. firms over the 2001–2019 period, we examine how brand capital affects firms’ debt choice, whether through bank borrowing or public debt issuance. Grounded in theoretical frameworks of information asymmetry, governance mechanisms, and financial conditions, we anticipate an inverse relationship between brand capital and reliance on bank debt. Our empirical findings align with these expectations, revealing that firms with higher levels of brand capital demonstrate a reduced reliance on bank debt compared with their counterparts with lower brand capital. Our results remain robust to a wide array of robustness tests. To mitigate potential endogeneity concerns, we implement a comprehensive set of tests, including the impact threshold for confounding variable specifications, Oster (2019) bound estimates, a heteroskedasticity-based instrumental variable approach, a two-step GMM method, an entropy balancing method regression, PSM, and a DiD regression approach. Notably, the impact of brand capital on firms’ debt choice emerges unscathed through all these tests.

Further insights emerge from our cross-sectional analyses, revealing that the negative association between brand capital and bank debt is more pronounced in firms characterized by high information asymmetry, weak corporate governance mechanisms, and poor financial conditions. Additional analyses shed light on the preference of brand capital-intensive firms for public debt, coupled with a nuanced use of secured and unsecured debt.

Abstract

While prior literature examines the role of certain incentives in motivating top managers (CEOs and CFOs) to engage in corporate tax avoidance, there is little evidence on the specific actions that managers take in response to these incentives. Motivated by the premise that a manager can influence a firm’s tax activities by directing resources towards the tax function, I investigate whether four specific tax avoidance incentives studied in prior literature (financial constraints, equity risk incentives, hedge fund interventions, and analyst cash flow forecasts) induce managers to make investments in hiring personnel within the firm’s tax department. Using a dataset of tax department employees collected from the professional networking website LinkedIn, I find evidence that each incentive is significantly associated with an increase in the number of individuals employed within the tax department. This association is generally stronger among higher ranked employees and employees with prior tax department experience. Overall, my findings are consistent with the premise that managers invest resources in the tax function when they are incentivized to avoid taxes. My study also provides some assurance that the association between tax avoidance incentives and effective tax rates documented in prior studies is reflective of intentional tax avoidance behavior.

Introduction

A large subset of the tax avoidance literature examines incentives that motivate top managers (CEOs and CFOs) to engage in corporate tax avoidance. The most common empirical approach in these studies is to examine the relationship between a specific incentive and tax planning outcomes of the firm, such as effective tax rates (ETRs). However, one drawback of this approach is that it provides no evidence regarding the specific actions that managers take in response to these incentives. Managers are unlikely to involve themselves directly in developing or implementing tax strategies given that they are rarely tax experts. Instead, the literature argues that they have a ‘tone at the top’ effect on the firm’s tax activities, which includes emphasizing the tax function when allocating resources across different functional areas of the firm (e.g. (Dyreng et al., 2010). Therefore, while prior studies focus on how tax avoidance incentives relate to outputs of the tax function (e.g. cash tax savings), managers will likely respond to these incentives by allocating resources to increase inputs into the tax function. Empirically, establishing an association between tax avoidance incentives and tax function inputs will provide stronger evidence regarding the effectiveness of these incentives. However, while tax function outputs are observable through publicly available financial statements, inputs are more difficult to measure.

In this study, I directly examine the relationship between tax avoidance incentives and inputs into the tax function – i.e. tax function investments. While investments in the tax function can be measured in different ways, I focus specifically on the quantity of tax personnel hired in the tax department. Indeed, (Mills et al., 1998) highlight that most tax function resources are allocated towards tax department personnel as opposed to outside assistance. The quantity of tax personnel hired is likely the most direct method of measuring tax department investments, has been shown in prior literature to be effective in generating tax savings (e.g. Chen et al., 2021, Barrios and Gallemore, 2023), and is publicly available through analyzing data from the professional networking website LinkedIn.

Conclusion

In this study, I examine whether managers respond to tax avoidance incentives by increasing investments made in the firm’s tax function, using the quantity of tax personnel employed as my primary measure. Using four types of incentives examined in prior literature – financial constraints, equity risk incentives, hedge fund interventions and analyst cash flow forecasts, and using a dataset of tax department employees collected from the professional networking website LinkedIn, I find that the quantity of tax personnel employed by the firm increases with each of the four incentives. My results are consistent with prior literature suggesting that managerial influence over firm tax planning is limited to ‘tone at the top’ effects, such as their ability to invest resources into the tax function.

Overall, my study complements prior literature examining these tax avoidance incentives by highlighting how inputs of the tax function respond to these incentives, in contrast with prior studies that only focus on outputs of the tax function (i.e. tax savings). The intuitive appeal of this approach is that it directly links these incentives with a specific managerial action, rather than the outcomes of these actions. The common definition of an ‘incentive’ involves the incitement of action and effort. However, since tax avoidance is not an area that managers generally specialize in, it is unlikely that managers exert effort personally in the development and execution of tax strategies. The results of my study suggest that the ‘action and effort’ incited by these incentives may be observable through an increase in tax personnel hiring, an indication that managers are allocating additional resources towards the tax function. Future researchers examining tax avoidance incentives may wish to strengthen their results by demonstrating, in conjunction with improved tax avoidance outcomes, that their incentive measure is related to an increase in tax function investments.

Abstract

In a sample of 1,097 European merger and acquisitions (M&A) deals, we find that the targets exhibiting higher levels of accruals earnings management (AEM) relate to lower ownership stakes offered by acquirers. Real earnings management (REM) measures do not relate to ownership decisions. This research contributes to broadening our knowledge about accounting information’s role in the intricacies of M&A negotiations.

Introduction

The ownership decision refers to how much equity acquirers aim to get from targets in mergers and acquisitions (M&A). The objective of this study is to examine how the manipulation of the target’s financial statements affects this decision.

Manipulated accounting figures generate uncertainty, and highly uncertain settings are associated with minority deals, which leads to expect that higher target’s earnings management (EM) relates to lower ownership stakes. However, the bidder may be unable to detect the manipulation, or it may be easier or more convenient to adjust other terms of the deal to overcome the overpayment risk.

We examine 1097 European deal announcements between 1990 and 2021, showing that higher discretionary accruals (DA), our proxy of accruals-based earnings management (AEM), are associated with lower ownership stakes and higher odds of minority deals. This suggests that, on average, acquirers are conservative regarding the equity stake they bid for when the target’s financial statements are opaque, making difficult the assessment of the potential synergies from the transaction.

We also find that real earnings management (REM) proxies do not correlate with the ownership decision. This is consistent with acquirers having more difficulties in understanding REM than AEM. Indeed, REM models are proven to be less powerful than AEM models (Nguyen et al., 2023). Alternatively, this result supports the thesis that REM is less pervasive than AEM (Bagnoli and Watts, 2000).

Conclusion

We add the target’s EM to the pool of non-controlling deal drivers (Drees et al., 2013; Liao, 2014; Povel and Sertsios, 2014; Soloveva et al., 2021). We find that buyers prefer to proceed cautiously and bid for small equity stakes and/or carry out non-controlling deals when they detect upward AEM in the target’s financial statements. This provides new insights into the usefulness of financial statements in the due diligence of M&A to avoid potential negative consequences of the transaction. Considering AEM might help acquirers make better-informed ownership decisions when dealing with overvaluation. Our evidence is consistent with prior research suggesting that the firms involved in non-controlling deals create wealth by aligning incentives and improving the information flow (Drees et al., 2013).

Our evidence is consistent with prior research suggesting that the firms involved in non-controlling deals create wealth by aligning incentives and improving the information flow (Drees et al., 2013). Moreover, our results are in line with recent evidence that, despite its relatively scarcity in the past, toeholds are useful when performing difficult takeovers, such as is the case in hostile deals, tender offers, or multiple bidders contests (Dai et al., 2021). Our results are relevant considering that takeovers are sophisticated transactions which parties have many terms to negotiate. Moreover, our findings are more than timely for practitioners in the current context of M&A, plagued by uncertainty and the looming threat of a recession, since rather than avoiding value-driven deals due to the overvaluation risk, they may use minority acquisitions strategically to mitigate the risks. However, this also poses an interesting question. If acquirers have many tools to prevent the overpayment risk, why are there M&A that destroy value? Very and Schweiger (2001) claim that acquirers usually lose money in M&A because of problems concerning the reliability of the target’s financial information and the integration process. Given our findings and those of other studies, showing that acquirers adjust the terms of the deal to mitigate the uncertainty derived from the target’s financial statements, future research should delve deeper into the integration phase of M&A to cast light on this question.