Earnings Quality of Foreign vs. U.S. Reverse Mergers: Geographical Location or Firm-Level Incentives?

37 Pages Posted: 3 Dec 2012 Last revised: 16 May 2015

See all articles by Chen Chu

Chen Chu

University of Texas at El Paso

Giorgio Gotti

University of Texas at El Paso (UTEP)

Kathryn M. Schumann

James Madison University

Date Written: September 6, 2014

Abstract

We test whether geographical location, audit quality and equity offering play a role in the earnings quality of Reverse Merger (RM) firms. We provide evidence that, contrary to the popular focus by the business press, earnings management happens in both U.S. and international RM companies. We find that firm-characteristics are more indicative of the likelihood to manage earnings than geographical location. The presence of a Big 4 auditor is associated with higher earnings quality and survival rate almost twice as much than for RM audited by a non-Big 4 auditor. Moreover, we find that, though earnings management is common practice at all RM firms, it is especially pervasive for RM firms that are issuing new equity after the reverse merger. Results of tests on these firm-level factors indicate that the differences in earnings quality are both statistically and economically significant and are robust to several sensitivity tests, including the use of different calculations of abnormal accruals.

Keywords: Earnings Quality, SEC, Reverse Merger, Audit Quality

JEL Classification: M41, G34, G38

Suggested Citation

Chu, Chen and Gotti, Giorgio and Schumann, Kathryn M., Earnings Quality of Foreign vs. U.S. Reverse Mergers: Geographical Location or Firm-Level Incentives? (September 6, 2014). Forthcoming in the Journal of International Accounting Research. Available at SSRN: https://ssrn.com/abstract=2184299 or http://dx.doi.org/10.2139/ssrn.2184299

Chen Chu

University of Texas at El Paso ( email )

El Paso, TX TX

Giorgio Gotti

University of Texas at El Paso (UTEP) ( email )

500 West University Avenue
El Paso, TX 79968-0542
United States

Kathryn M. Schumann (Contact Author)

James Madison University ( email )

Harrisonburg, VA 22807
United States

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