۱- Introduction

۲- Literature and hypothesis development

۳- Data and methodology

۴- Tests of earnings management

۵- Earnings management and MBO performance

۶- Conclusion

References

Abstract

Purpose
The purpose of this paper is to examine the effect of pre-acquisition earnings management on the performance of private firm management buyouts. Design/methodology/approach
The study examines 291 UK private firms acquired by their managers between 2004 and 2012. Earnings management is investigated by means of cross-sectional discretionary accruals models, and estimated discretionary accruals are regressed on performance changes in the three years following acquisition.
Findings
Management buyouts of private firms are preceded by earnings overstatement and followed by performance deterioration. Private equity sponsored firms engage less in earnings management and remain more profitable than non-sponsored buyouts. Upward earnings managers cease to outperform industry after second post-buyout year, while aggressive earnings managers do not outperform industry at all. Discretionary total accruals are inversely associated with performance changes in the three years after buyout, and explain over 4 per cent of the changes in performance.
Research limitations/implications – Pertinent to the utilisation of private firms and their exemption from publishing cash flow statement, the study relies on accrual-based models for tests of earnings management.
Originality/value
The paper contributes to the mergers and acquisitions literature and value creation debate in buyouts by providing the first tests of earnings management and post-acquisition performance in private firm management buyouts.

Introduction

Existing literature shows widespread earnings management before going private acquisitions (Perry and Williams, 1994; Wu, 1997; Fischer and Louis, 2008; Mao and Renneboog, 2015). The managerial self-interest inherent to MBO acquisitions provides sufficient incentives and forms an ideal setting for managers to exercise their discretion over accruals and understate earnings to pay an undervalued equity price. However, the current research has an exclusive focus on going private buyouts. This study investigates earnings management preceding private firm MBOs and follows up with post-acquisition performance investigation. The private firm choice is motivated by the fact that private firms are the largest source of buyouts worldwide (Strömberg, 2008). In the UK, private firms are subject to the same reporting requirements as public firms as they file annual reports with the registrar. EU fourth Directive Article 47(1) and 51(1), respectively, state that companies must make their annual reports publicly accessible and have their financial accounts audited. The fourth Directive also clarifies that member states can lighten publication requirements of annual accounts for small and medium sized companies and auditing exemptions can be introduced for small companies. In particular, private firms are exempt from publishing cash flow statement. These regulations enable us to utilise a fairly large sample of private firms for tests. Another motivating factor is the lack of event-based studies for private firms. Past research is either based on case studies (Howorth et al., 2004), or multi-country private firm populations (Burgstahler et al., 2006) absent a major corporate event.