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Do Managers Manipulate Earnings Prior to Management Buyouts?

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  • Mao, Y.
  • Renneboog, L.D.R.

    (Tilburg University, Center for Economic Research)

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    Abstract

    Abstract: To address the question as to whether managers manipulate accounting numbers downwards prior to management buyouts (MBOs), we implement an industry-adjusted buyout-specific approach and receive an affirmative answer. In UK buyout companies, negative earnings manipulation (understating the earnings prior to the deal) often occurs, both by means of accrual management and real earnings management. We demonstrate that MBOs are significantly more frequently subject to negative manipulation than leveraged buyouts (LBOs). In non-buyout firms, positive earnings management frequently occurs because it affects managers’ bonuses and the likelihood of meeting or beating analysts’ expectations which may trigger a positive market reaction. By means of an instrumental variables approach, we examine competing incentives affecting the degree and size of earnings manipulation. Our evidence implies that the (ex ante) perceived likelihood that an MBO will be undertaken has a strong significant effect on negative earnings management, while the external borrowing capacity of the buyout company is not determined by standard capital structure factors, such as earnings numbers. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real management in MBOs, but since then other manipulation techniques (related to production costs and asset revaluations) are more frequently used, which may be induced by the fact that these manipulation methods are more difficult to detect.

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    Bibliographic Info

    Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2013-055.

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    Date of creation: 2013
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    Handle: RePEc:dgr:kubcen:2013055

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    Web page: http://center.uvt.nl

    Related research

    Keywords: Accounting manipulation; earnings management; leveraged buyout; management buyout; LBO; MBO;

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    References

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    1. Y.C. Lin & Ken V. Peasnell, 2000. "Fixed Asset Revaluation and Equity Depletion in the UK," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(3-4), pages 359-394.
    2. :Jana P. Fidrmuc & Peter Roosenboom & Dick J.C. Van Dijk, 2009. "When Do Managers Seek Private Equity Backing in Public-to-Private Transactions?," Working Papers wpn09-02, Warwick Business School, Finance Group.
    3. Ervin L. Black & Keith F. Sellers & Tracy S. Manly, 1998. "Earnings Management Using Asset Sales: An International Study of Countries Allowing Noncurrent Asset Revaluation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 25(9-10), pages 1287-1317.
    4. Steven N. Kaplan & Per Stromberg, 2009. "Leveraged Buyouts and Private Equity," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 121-46, Winter.
    5. C.S. Agnes Cheng & Stephen W.J. Lin, 2009. "When do firms revalue their assets upwards? Evidence from the UK," International Journal of Accounting and Information Management, Emerald Group Publishing, vol. 17(2), pages 166-188, June.
    6. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    7. Antonia Botsari & Geoff Meeks, 2008. "Do Acquirers Manage Earnings Prior to a Share for Share Bid?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(5-6), pages 633-670.
    8. Cohen, Daniel A. & Zarowin, Paul, 2010. "Accrual-based and real earnings management activities around seasoned equity offerings," Journal of Accounting and Economics, Elsevier, vol. 50(1), pages 2-19, May.
    9. John R. Graham & Campbell R. Harvey & Shiva Rajgopal, 2004. "The Economic Implications of Corporate Financial Reporting," NBER Working Papers 10550, National Bureau of Economic Research, Inc.
    10. Roychowdhury, Sugata, 2006. "Earnings management through real activities manipulation," Journal of Accounting and Economics, Elsevier, vol. 42(3), pages 335-370, December.
    11. Anil Shivdasani & Yihui Wang, 2011. "Did Structured Credit Fuel the LBO Boom?," Journal of Finance, American Finance Association, vol. 66(4), pages 1291-1328, 08.
    12. Paul E. Fischer & Henock Louis, 2008. "Financial Reporting and Conflicting Managerial Incentives: The Case of Management Buyouts," Management Science, INFORMS, vol. 54(10), pages 1700-1714, October.
    13. Kothari, S.P. & Leone, Andrew J. & Wasley, Charles E., 2005. "Performance matched discretionary accrual measures," Journal of Accounting and Economics, Elsevier, vol. 39(1), pages 163-197, February.
    14. Shourun Guo & Edith S. Hotchkiss & Weihong Song, 2011. "Do Buyouts (Still) Create Value?," Journal of Finance, American Finance Association, vol. 66(2), pages 479-517, 04.
    15. Ball, Ray & Shivakumar, Lakshmanan, 2008. "Earnings quality at initial public offerings," Journal of Accounting and Economics, Elsevier, vol. 45(2-3), pages 324-349, August.
    16. Dechow, P.M., 1992. "Accounting Earnings and Cash Flows as Measures of Firm Performance: The Role of Accounting Accruals," Papers 59, Rochester, Business - Ph.D.,.
    17. Paul Hribar, 2002. "Errors in Estimating Accruals: Implications for Empirical Research," Journal of Accounting Research, Wiley Blackwell, vol. 40(1), pages 105-134, 03.
    18. Y.C. Lin & Ken V. Peasnell, 2000. "Fixed Asset Revaluation and Equity Depletion in the UK," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(3&4), pages 359-394.
    19. Perry, Susan E. & Williams, Thomas H., 1994. "Earnings management preceding management buyout offers," Journal of Accounting and Economics, Elsevier, vol. 18(2), pages 157-179, September.
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