Do Financial Statement Misstatements Facilitate Corporate Acquisitions?

Abstract:     
We investigate the association between corporate acquisition activity and the incidence of income-increasing financial statement misstatements, and we ask whether misstatements facilitate acquisitions. For firms that make acquisitions after misstating their financial reports, we find that acquisition announcements typically occur shortly after the first misstated report. We also find that the use of stock consideration increases the probability that managers misstate earnings before acquisitions by a substantial amount, and that misstatements beginning before stock-based acquisitions tend to be significantly larger than other misstatements. Controlling for restatement severity, we find that stock price reactions to restatement announcements are more negative, by 140 basis points on average, when acquisitions are made during the misstatement period. We also find that acquisitions made during misstatement periods are significantly more likely to result in goodwill impairments than are acquisitions made during non-misstatement periods. Collectively, these results suggest that managers intentionally inflate earnings in anticipation of acquisitions, and that acquisitions made during misstatement periods are more likely to be value destroying.

Number of Pages in PDF File: 49

Keywords: Misstatements, Restatements, Earnings Management, Mergers, Acquisitions

JEL Classification: G14, G34, M41, M43

working papers series