Earnings management at target firms and the acquirers’ performance

This study examines earnings management (EM) at target firms before and after the Sarbanes-Oxley Act 2002 (SOX) was implemented and explains the post-merger underperformance of the acquirers. Using a sample of US listed firms that are targets of successful acquisitions over the period 1987–2017, we find evidence of real and accrual EM in the eight quarters leading up to the date when the merger is announced. Through a careful examination of the two forms of EM, we find that the target firms manage real activities both before and after SOX went into effect. However, accrual EM is significant among target firms in stock-based acquisitions before SOX took effect. The findings further suggest that the target firms’ pre-merger EM is negatively associated with the short-term returns of the targets and the long-run performance of the acquirers. More specifically, we find that target firms’ pre-merger real EM is a significant determinant of the acquirers’ negative long-run performance. Our results are robust after controlling for acquirers’ EM, deal-level, and firm-level characteristics.