Time will tell the truth: Performance commitments and earnings management in M&A

Abstract

This study investigates the impact of performance commitments on the earnings management levels of acquiring firms in the three years following mergers and acquisitions (M&As), as well as the resulting performance reversal phenomenon. The empirical results indicate that listed companies significantly increase their earnings management levels in the three years after making performance commitments. This suggests that firms may engage in upward earnings management during the commitment period to inflate profits and achieve the promised performance. Moreover, our findings reveal that M&A transactions involving stock payments and performance commitments exhibit even higher levels of earnings management. However, such practices are unsustainable; once the commitment period ends, the previous earnings management behavior is gradually rectified, leading to a performance reversal. Further analysis demonstrates that performance commitments result in a significant decline in companies' return on assets (ROA) in the fourth and fifth years post-M&A.