Does Target Firm’s Earnings Management Affect Shareholder’s Gains? Evidence from China

Abstract

This study tests the hypothesis that the target firms are involved in earnings management activities in quarters leading to a takeover announcement. Using a sample of 3,455 Chinese listed firms that are targets of successful acquisitions over the period 2007 – 2020, and for a matched sample of non-targets, we find that target firms manipulate earnings in quarters leading to the announcement date. Further, we find evidence of a negative relationship between earnings management and short-term gains to shareholders. Our result remains robust after controlling for various deal characteristics. The study also suggests that pre-merger earnings management in target firms is not fully anticipated by the market before the takeover announcement. We find no evidence of earnings management immediately after the announcement quarter. the target firm’s shareholders gain as a result of a takeover. As for the relationship between EM and shareholders’ gains, the results indicate that the target firms’ shareholders returns are greater in firms that exhibit low EM showing an inverse relationship between pre-merger EM and shareholders’ gains. The addition of control variables in the regression model supports our main results. The results are consistent with previous literature. This study also supports the takeover defense and financial incentive hypothesis found in previous studies. Our findings also indicate that the pre-merger EM by target firms is not fully anticipated by the mar-OPEN