Accounting conservatism and the fulfilment of the target’s performance commitment in valuation adjustment mechanism contracts

ABSTRACT

We find that acquiring firm’s accounting conservatism positively affects the likelihood of targets fulfilling their performance commitments in valuation adjustment mechanism (VAM) contracts in merger and acquisition (M&A) deals. The effect is more pronounced when the acquirer is in a high-competition industry and audited by non-Top eight accounting firms and the deal is cross-region. Further tests show that accounting conservatism increases the likelihood of fulfilment by lowering the targets’ promised standards and increasing managers’ incentive to motivate and monitor targets’ managers after M&A. Finally, the performance of conservative acquirers is better after VAM contract expires.

KEYWORDS:

• Accounting conservatism
• fulfilment of the target’s performance commitment
• valuation adjustment mechanism contracts
• M&A

Acknowledgments

Li Wenfei and Tang Qingquan thank the National Natural Science Foundation of China (Project NO. 71702038, 71672204). We thank the editors and the anonymous reviewers for the constructive comments and suggestions. All remaining errors are our own.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Chen et al.(2011) combine Big four 4 and National Top four audit firms, referring them as Top eight audit firms and classifying them as high-quality auditors. Following Chen et al. (2011), we classify Big four and National Top four audit firms as high-quality auditors.

2. The reason for choosing the unlisted target is as follows: The disclosure requirements of listed targets are stricter than those of unlisted targets. Therefore, the fulfilment of a listed target’s performance commitment may be affected by the better outside supervision before and after M&A rather than the acquirer’s accounting conservatism.

3. This argument is supported by the descriptive statistic Promiseadd in the latter part.

4. As to the variables of the acquiring firm’s characteristics and target firm’s characteristics, we use the data from one year before the disclosure of M&A announcement. The subscript ‘t’ in Model 3 indicates one year before the disclosure of M&A announcement.

5. We require that each industry has at least 10 samples each year, which results in 13 missed samples.

6. Top four accounting firms are the accounting firms that rank top four according to the list of Top 100 accounting firms disclosed every year by the CICPA.

Additional information

Funding

This work was supported by the National Natural Science Foundation of China [71672204,71702038]; Natural Science Foundation of Guangdong Province [2015A030313074]; Philosophy and Social Science Planning Project of Guangdong Province [GD13CGL06].