Institutional investors, corporate governance, and earnings management around merger: evidence from French absorbing firms/Inversores institucionales, gobierno corporativo y gestión de los resultados alrededor de una fusión: el caso de las empresas absorbentes francesas.
| Autor | Njah, Mouna |
| Cargo | Art |
1. Introduction
Further to their increasing presence in the financial markets, institutional investors have become the subject matter of several academic papers. The majority of the conducted studies have tried to treat the role carried out by these actors in their respective companies, highlighting their contribution in creating shareholder value. In this context, several studies have made it clear that it is uncertain for most of the institutional investors to behave in the same way. Indeed, they assert the existence of different types of institutional investors who differ according to the business characteristics and objectives they undertake (Ruiz-Mallorqui & Santana-Martin, 2011). This theoretical finding has been well explained by the hypothesis of institutional investors' heterogeneity behavior (e.g., Brickley, Lease & Smith, 1988; Dong & Ozkan, 2008; Duggal & Millar, 1994; Gillan & Starks, 2003; Ruiz-Mallorqui & Santana-Martin, 2011; Wang & Zhang, 2009). Actually, the control behavior exercised by such shareholders is not unique and precise; it is, rather, heterogeneous and complex (Ben M'Barek, 2003).
Recent studies dealing with institutional investors and their impact on accounting choices have predominantly focused on the latter's contribution to control the opportunist managerial practices. Noteworthy, however, the theoretical and empirical contributions related to this area of research are very controversial. In fact, while Koh (2003, 2007), Ben Kraiem (2008), Jarboui and Njah (2010), find that institutional investors are playing an active role in monitoring and disciplining managerial discretion, other empirical studies suggest that this institutional type of ownership is likely to increase the managerial incentives to adopt an aggressive earnings-management strategy (e.g., Cheng & Reitenga, 2001; Koh, 2003; Lipson, Kedia & Burns, 2006; Koh, 2007).
Owing to these ambiguities and to the difficulty of identifying the control behavior of institutional investors, we have reckoned it interesting to study the institutional investor's control behavior in an incentive context of earnings management. In this paper, we tend to examine the relationship between institutional investors and earning-management behavior with respect to some French merger and acquisition undertaking. More specifically, we investigate, on the one hand, to what extent the institutional investor's control behavior can affect the acquiring firm's accounting policy. On the other hand, we tend to analyse the acquiring firm's major determinants of earnings management.
Using a sample of 76 French mergers and absorptions occurring over the period 2000-2010, the results show that the absorbing firm's tend to manipulate the earnings relevant to the year preceding the merger offer. In addition, the achieved results indicate that the absorbing firms' upwards earnings management proves to be positively influenced by institutional cross-holding and the existence of a pre-bid toehold shareholding by bidding companies. However, the presence of active institutions decreases the level of discretionary accruals of the absorbent companies.
The remainder of this paper is organized as follows. Section 2 is devoted to develop the paper's hypothesis. As for section 3, it contains the research methodology (variable measurements, research design, and samples applied). In section 4, the empirical results are exposed, while section 5 depicts the conclusion.
2. Hypothesis development
2.1. The absorbent company's accounting politics: earnings anagement hypothesis
Financial and accounting literature is rich and unanimous as to the validity of earnings-management hypothesis pertaining to mergers and acquisitions (e.g., Erickson and Wang, 1999; Gong, Louis & Sun, 2008, Groff & Wright, 1989; Higgins, 2013, and Louis, 2004). This hypothesis predicts that the acquiring firms manage their earnings during the period prior to the merger offer.
In the context of mergers and acquisitions, earnings management can be viewed as either opportunistic or beneficial. In this regard, Jiraporn, Miller, Yoon and Kim (2008) suggest that earnings management may seem beneficial as it potentially enhances the informative-value of earnings.
Managers of the acquiring firms may exercise managerial discretion over earnings to communicate private information to current and potential investors. It is intended to reflect their investment opportunities and future growth in order to affect the perception of initiator shareholders and those of the target companies about the quality of the merger offer.
In general, an opportunistic earnings management undertaken by acquirer may have two major explanations. On the one hand, it serves to conceal the managerial entrenchment strategy (Andre, Ben-Amar & Lain, 2003). Entrenched managers will be incited to manipulate earnings in order to enhance the entrenchment policies through merger and acquisition bids. On the other hand, the acquiring firms' upward earnings management would tend to reduce the exchange ratio (Boutant, 2011; Higgins, 2013). In this context, Erickson and Wang (1999) find that bidder managers manage earnings in such a way as to affect the exchange ratio, stock dilution and target-acquisition cost.
The hypothesis of earnings management prior to the mergers and acquisitions is also valid in the specific context of merger and absorption transactions (e.g., Boutant, 2010; Djama & Boutant, 2006; Nasfi & Albouy, 2011). In this specific context, we tend to examine the relationship between institutional investors and earning-management behavior.
2.2. Institutional ownership and earnings management incentives
For the purpose of examining the institutional investors' ability and incentives to monitor earnings management, we reckon to divide institutions into "transient" and "dedicated" groups, in conformity with the research line of Brickley et al. (1988), Duggal and Millar (1994), Bushee (1998), Almazan, Hartzell and Starks (2005), Velury and Jenkins (2006), Dong and Ozkan (2008), Ferreira and Matos (2008), Bhattacharya and Graham (2009).
2.2.1. Transient institutional investors
Dong and Ozkan (2008), note that the transient institutions are but institutional investors who buy and sell their investments very frequently and exhibit a high portfolio turnover. These institutions are characterized by adopting a short investment horizon (Jarboui and Olivero, 2008) and indexing objectives (Elyasiani and Jia, 2010). They often choose to follow the "Wall Street Rule". In fact, transient institutional investors are not directly involved in corporate management decisions. Once dissatisfied with the firm's management or stock-market performance, they simply adopt an exit policy by selling their stakes (Tsai and Gu, 2007). Indeed, they are willing to give up their managerial control-decision rights for the sake of profiting from liquidity advantages of their portfolios. Such a detachment from the control activity can be qualified as being synonymous of passivity (Ben Kraeim, 2008).
In this respect, Bushee (2001) highlights that transient institutional investors most often exhibit a strong preference for shortterm earnings. It is actually this excessive focus on current earnings that entices firm managers to manage earnings upwards (Koh, 2003). In fact, these investors are ready to encourage managerial opportunistic practices if they generate significant abnormal returns. More recent studies have shown that the presence of institutional investors is likely to further increase incentives to earnings management. For instance, Koh (2007) predicts a positive association between transient institutional ownership and income-increasing earnings management. In consistence with this empirical evidence, Cheng and Reitenga (2001), Koh (2003) and Lipson et al. (2006) report that institutional ownership is highly associated with income increasing accruals.
Regarding the existing literature, it suggests that some institutional investors do have a certain business relationship with some firms. Such institutions are, generally, less likely to oppose managerial decisions, thus impeding, their effective monitoring-managerial discretion. Consequently, managers tend to have more liberties of commitment in mergers and acquisitions even though they may not create enough value. The neutrality of transient institutional investors with regards to a merger long-run profitability is explained by their preference to abandon their control rights in favor of consolidating the diversification and liquidity advantages.
In the context of mergers and absorptions, the absorbing-company executives are more able to manage earnings upwards in the period prior to a merger offer during the existence of transient institutional ownership. This theoretical evidence has its justification in two major arguments. Firstly, these transactions favor the primary objective of maximizing the shareholder's value further to achieving positive abnormal returns when announcing the absorption offer (Comble & Heldenbergh, 2002). Secondly, such a specific accounting strategy complies with near-term earnings preference adopted by transient institutional investors. This set of arguments support the following hypothesis stipulating that:
H1. Absorbent firms are more incited to manage earnings upwards during the year preceding a merger in presence of transient institutional ownership.
2.2.2. Dedicated institutional investors
Dedicated institutional investors are characterized as being long-term oriented investors with a desire to invest in a firm which creates a long-run value. In this context, previous research works (e.g., Brickley et al., 1998; Bushee, 1998; Chen, Harford & Li, 2007; Hartzell & Starks, 2003; Ramalingegowda & Yu, 2012; Sahut & Gharbi, 2010) have suggested that institutions that have long-investment horizons and concentrated-share focused holdings are most likely to monitor managers...
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