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.