Earnings Management and the Market Performance of Acquiring Firms

Posted: 4 Dec 2003

See all articles by Henock Louis

Henock Louis

Pennsylvania State University - Smeal College of Business

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Abstract

I examine the market's efficiency in processing manipulated accounting reports and provide an explanation for the post-merger underperformance anomaly. I find strong evidence suggesting that acquiring firms overstate their earnings in the quarter preceding a stock swap announcement. I also find evidence of a reversal of the stock price effects of the earnings management in the days leading to the merger announcement. However, the pre-merger reversal is only partial. There is evidence of a post-merger reversal of the stock price effects of the pre-merger earnings management. The results suggest that the extant evidence of post-merger underperformance by acquiring firms is partly attributable to the reversal of the price effects of earnings management. The study also suggests that the post-merger reversal is not fully anticipated by financial analysts in the month immediately following the merger announcement. However, consistent with suggestions in the financial press that managers guide analysts' forecasts to "beatable" levels, the effect of the earnings management reversal seems to be reflected in the consensus analysts' forecasts by the time of the subsequent quarterly earnings releases.

Keywords: earnings management, merger, analyst forecast, market efficiency, rational expectations, long-term performance, accruals

JEL Classification: G34, M41, M43, G29, G14

Suggested Citation

Louis, Henock, Earnings Management and the Market Performance of Acquiring Firms. Journal of Financial Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=467487

Henock Louis (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802-3306
United States
814-865-4160 (Phone)
814-863-8393 (Fax)

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