Does Investment-Related Pressure Lead to Misreporting? An Analysis of Reporting Following M&A Transactions

Abstract

Agency theory suggests that if a principal observes a signal suggesting that an agent has made a value-destroying decision, then the principal would be more likely to dismiss that agent. We label the increase in the pressure a manager feels to retain his job following an acquisition poorly received by the market as investment-related pressure. We examine whether experiencing this form of pressure alters managers’ financial reporting decisions. We hypothesize that CEOs attempt to assuage investment-related pressure by delivering strong performance post-merger, creating incentives for misreporting. Using a sample of M&A firms, we find that acquirers with more negative M&A announcement returns are more likely to misstate financial statements in the post-investment period. Our findings also suggest that the issuance of misstated financials mitigates the investment-related pressure at least in the near term before the misstatement is revealed. Our study contributes to the literature on the relation between corporate investing and financial reporting by showing how investment-related pressure leads to misreporting, even in a setting where the costs of intentional misstatements (e.g., greater probability of detection due to greater scrutiny) are high. Our study also has implications for the large body of research that evaluates various consequences of M&A transactions using post-merger performance. Empirical studies should be careful to distinguish real from misstated financial performance in the post-investment period.

Keywords: misreporting, investment, mergers and acquisitions, pressure on managers

JEL Classification: G34, M41