Does High Leverage Impact Earnings Management? Evidence from Non-Cash Mergers and Acquisitions

Abstract

Using a sample of US noncash
\nacquirers, we find significant evidence of upward earnings
\nmanagement prior to announcing merger and acquisition deals. In this event study, we adopt an
\nindustryadjusted
\nleverage proxy. No evidence of premerger earnings management is found in
\nhighly leveraged firms. The results indicate significant evidence of a negative relationship
\nbetween earnings management and leverage. The evidence remains robust after replacing the
\nleverage proxy with a highlow
\nleverage binary variable, as well as after controlling for the
\nrelative size of the deal and profitability of acquirers. No evidence on earnings management by
\ncash acquirers is reported. These findings are consistent with Jensen’s Control Hypothesis as well
\nas advocate the view that creditors play crucial roles in monitoring the firm, which would
\nincrease the credibility of corporate reports and restrict the use of management’s discretionary
\npower to manipulate earnings prior to special business events such as mergers and acquisitions.