Do Managers Manipulate Earnings Prior to Management Buyouts?

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Abstract

Abstract: To address the question as to whether managers manipulate accounting numbers downwards prior to management buyouts (MBOs), we implement an industry-adjusted buyout-specific approach and receive an affirmative answer. In UK buyout companies, negative earnings manipulation (understating the earnings prior to the deal) often occurs, both by means of accrual management and real earnings management. We demonstrate that MBOs are significantly more frequently subject to negative manipulation than leveraged buyouts (LBOs). In non-buyout firms, positive earnings management frequently occurs because it affects managers’ bonuses and the likelihood of meeting or beating analysts’ expectations which may trigger a positive market reaction. By means of an instrumental variables approach, we examine competing incentives affecting the degree and size of earnings manipulation. Our evidence implies that the (ex ante) perceived likelihood that an MBO will be undertaken has a strong significant effect on negative earnings management, while the external borrowing capacity of the buyout company is not determined by standard capital structure factors, such as earnings numbers. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real management in MBOs, but since then other manipulation techniques (related to production costs and asset revaluations) are more frequently used, which may be induced by the fact that these manipulation methods are more difficult to detect.
Original languageEnglish
Place of PublicationTilburg
PublisherFinance
Number of pages45
Volume2013-055
Publication statusPublished - 2013

Publication series

NameCentER Discussion Paper
Volume2013-055

Fingerprint

Management buyouts
Managers
Buy-out
Manipulation
Earnings management
Earnings manipulation
Industry
Production cost
Analysts
Market reaction
Bonuses
Asset revaluations
Leveraged buyouts
Borrowing
Corporate governance codes
Incentives
Factors
Trigger
Capital structure
Instrumental variables

Keywords

  • Accounting manipulation
  • earnings management
  • leveraged buyout
  • management buyout
  • LBO
  • MBO

Cite this

Mao, Y., & Renneboog, L. D. R. (2013). Do Managers Manipulate Earnings Prior to Management Buyouts? (CentER Discussion Paper; Vol. 2013-055). Tilburg: Finance.
Mao, Y. ; Renneboog, L.D.R. / Do Managers Manipulate Earnings Prior to Management Buyouts?. Tilburg : Finance, 2013. (CentER Discussion Paper).
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Mao, Y & Renneboog, LDR 2013 'Do Managers Manipulate Earnings Prior to Management Buyouts?' CentER Discussion Paper, vol. 2013-055, Finance, Tilburg.

Do Managers Manipulate Earnings Prior to Management Buyouts? / Mao, Y.; Renneboog, L.D.R.

Tilburg : Finance, 2013. (CentER Discussion Paper; Vol. 2013-055).

Research output: Working paperDiscussion paperOther research output

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N2 - Abstract: To address the question as to whether managers manipulate accounting numbers downwards prior to management buyouts (MBOs), we implement an industry-adjusted buyout-specific approach and receive an affirmative answer. In UK buyout companies, negative earnings manipulation (understating the earnings prior to the deal) often occurs, both by means of accrual management and real earnings management. We demonstrate that MBOs are significantly more frequently subject to negative manipulation than leveraged buyouts (LBOs). In non-buyout firms, positive earnings management frequently occurs because it affects managers’ bonuses and the likelihood of meeting or beating analysts’ expectations which may trigger a positive market reaction. By means of an instrumental variables approach, we examine competing incentives affecting the degree and size of earnings manipulation. Our evidence implies that the (ex ante) perceived likelihood that an MBO will be undertaken has a strong significant effect on negative earnings management, while the external borrowing capacity of the buyout company is not determined by standard capital structure factors, such as earnings numbers. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real management in MBOs, but since then other manipulation techniques (related to production costs and asset revaluations) are more frequently used, which may be induced by the fact that these manipulation methods are more difficult to detect.

AB - Abstract: To address the question as to whether managers manipulate accounting numbers downwards prior to management buyouts (MBOs), we implement an industry-adjusted buyout-specific approach and receive an affirmative answer. In UK buyout companies, negative earnings manipulation (understating the earnings prior to the deal) often occurs, both by means of accrual management and real earnings management. We demonstrate that MBOs are significantly more frequently subject to negative manipulation than leveraged buyouts (LBOs). In non-buyout firms, positive earnings management frequently occurs because it affects managers’ bonuses and the likelihood of meeting or beating analysts’ expectations which may trigger a positive market reaction. By means of an instrumental variables approach, we examine competing incentives affecting the degree and size of earnings manipulation. Our evidence implies that the (ex ante) perceived likelihood that an MBO will be undertaken has a strong significant effect on negative earnings management, while the external borrowing capacity of the buyout company is not determined by standard capital structure factors, such as earnings numbers. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real management in MBOs, but since then other manipulation techniques (related to production costs and asset revaluations) are more frequently used, which may be induced by the fact that these manipulation methods are more difficult to detect.

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Mao Y, Renneboog LDR. Do Managers Manipulate Earnings Prior to Management Buyouts? Tilburg: Finance. 2013. (CentER Discussion Paper).