Earnings Management of Acquiring Firms in Stock-for-Stock Takeovers in the Telecommunications Industry

Abstract

This article investigates whether acquiring telecommunications firms managed their earnings by means of discretionary accruals prior to the announcement of stock-for-stock takeovers in the U.S. telecommunications industry during the period of 1990 to 2006. The results show that acquiring telecommunications firms manage earnings upward prior to stock-for-stock takeovers. In addition, this article finds that there is a negative short-term wealth effect over the days surrounding stock-for-stock takeover announcements, and there is an inverse relation between earnings management and short-term wealth.

ACKNOWLEDGMENTS

This research was financially supported by the Korean government, under the Information Technology Research Center support program.

Notes

¹As Erickson and Wang (1999) mentioned, the number of acquiring firm's shares exchanged for each share of the target firm is determined by the price of the acquiring firm's stock when the merger agreement is reached, given the agreed-on target firm purchase price. Therefore, the higher the price of the acquiring firm's stock on the agreement date, the fewer the shares that must be issued to purchase the target firm.

²According to Louis (2004), among the sample of 236 pure stock swaps and 137 pure cash mergers that took place between 1992 and 2000, there were 14 stock-swap mergers in the telecommunications industry but only 2 cash mergers in that industry.

³According to Warf (2003), of all worldwide mergers and acquisitions between 1993 and 2000, 70% of the purchases originated in the United States and 60% of the target firms came from there.

⁴First, this article selected a sample based on the standard industrial classification major group 48, which refers to the “communications industry” (i.e., telephone, radio, TV, and CATV). Second, this article excluded acquiring firms involved in acquiring only a proportion of fixed assets, but not ownership, following the research of Koumanakos, Siriopoulos, and Georgopoulos (2005). Third, this article excluded any hostile takeovers or tender offers because these transactions do not involve the negotiation of an exchange ratio, and the stock price is not as relevant as in the case of negotiated mergers (Erickson & Wang, 1999).

⁵This article only considers mixed mergers for which the value of the stock is more than 50% of the acquisition price.

⁶This article also eliminated the second transaction for certain multiple transaction acquirers from our sample. When we eliminate the second transaction, it is because of a short window period with which to estimate parameters (we need at least 14 quarters in the interval—the windows are from −4 to +4 quarters surrounding the transaction, and 6 quarters are needed for the regression and test statistics). Otherwise, no second sample is eliminated. Most other takeovers were eliminated from the sample because of the absence of data used in the computation of working capital accruals (e.g., taxes payable). The data are analyzed using COMPUSTAT.

⁷This announcement date was selected because the date is very close to the agreement date in most cases, and it is publicly disclosed.

*p = .01.

^a The number of telecommunications acquirers for which abnormal returns were estimated was reduced because some firms were excluded because of a lack of data used in the computation of abnormal returns.

^b CAR[−1, 1] is the abnormal return cumulated over the day of the merger announcement, the preceding day, and the day after; CAR[0, 1] is the abnormal return cumulated over the merger announcement and the day after.

*p = .10.

**p = .05.

***p = .01.

*p = .10.

**p = .05.