By Liz Warren-Pederson
When stocks drop in the wake of a high-profile merger, the pressure’s on for management to prove that the strategy was sound – which means there’s more incentive for them to demonstrate positive post-merger operating performance to stockholders.
A new paper co-authored by associate professor of accounting Dan Bens(associate dean and Eller MBA director and Frank and Susan Parise Fellow) and assistant professors of accounting Theodore Goodman and Monica Neamtiu demonstrates that investment-related pressure can lead to misreporting after mergers and aquisitions (M&A).
“We find that firms with unfavorable merger announcement returns are more likely to misstate their financial statements and to issue optimistic long-term managerial guidance in the post-merger period,” Bens explained.
The existing literature found mixed evidence with respect to the relationship between pressure and financial misreporting, and no evidence of an effect of investment-related pressure on financial reporting outcomes. But Bens, Goodman, and Neamtiu designed their research around a well-defined scenario so that they could hone in on the underlying phenomenon.
“If a company builds a plant somewhere, the impact of that investment is not as transparent,” Bens said. “Our goal was to look at M&A investments with a lot of significance, the kind that are picked up in the national media.”
A bad merger on that scale could certainly put a CEO’s job at risk, but wouldn’t the added media attention be a deterrent to biased reporting? Not necessarily, said Bens.
“When people are under pressure, they do irrational things,” he said. “But any manipulation a firm tries to do with earnings management will always unwind eventually.”
Eventually is the key word. “The interesting thing about this paper is that we show that it seems to work in the short term,” Bens said. “The turnover rate is lower for these guys in the first year. But somwhere down the line, that CEO is going to have to pay the piper.”
That was certainly the case with the corporate data that Bens, Goodman, and Neamtiu examined, but Bens hastens to point out that cooking the books is aberrant behavior. “This is a select group, in which the pressure is on to prove that the merger was a good decision,” he said.
“When the stock market thinks a merger was bad,” he continued, “governing boards and shareholders should look carefully at post-merger numbers.”