This paper investigates whether stock-for-stock acquirers undertake real activities to manage earnings before merger announcements. Our results show that stock-for-stock acquirers present unusually high levels of credit sales and overproduction in the quarter immediately before the merger announcement. We also find that the accruals feature of real earnings management can explain the stock-for-stock acquirers’ high discretionary current accruals. In addition, stock-for-stock acquirer firms that accelerate their credit sales experience subsequent market underperformance. Overall, we provide a novel insight into the accruals feature of real earnings management.

Introduction

In a stock-for-stock merger, the higher stock price of the acquirer firm on the agreement date benefits the acquirer by lowering the number of shares used to purchase the target firm, thus reducing the cost of the acquisition. Previous studies show that acquirers exhibit higher discretionary current accruals (DCA) in the quarter immediately before their stock-forstock merger announcement, suggesting engagement in managing current accruals, and attribute acquirers’ subsequent underperformance to the reversal effects and litigation costs of the upward current accruals (Erickson and Wang, 1999; Gong et al., 2008; Louis, 2004). In this paper, we reinvestigate the upward management of current accruals of stock-forstock acquirers (stock acquirers) from the perspective of real earnings management (REM). Our motives for this investigation stem from the fact that merger announcements are important events that attract attention from market participants (Liu and McConnell, 2013; Louis and Sun, 2010; Maksimovic and Phillips, 2001; Schoar, 2002). Acquirers come under market scrutiny and have limited ability to engage in accrual-based earnings management (AEM) (Burnett et al., 2012; Chi et al., 2011; Cohen and Zarowin, 2010; Graham et al., 2005; Zang, 2012). Therefore, it is of interest to investigate whether stock acquirers use an alternative mean to boost their pre-merger earnings.