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Management International Review

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01.10.2015 | Research Article

The Role of Institutional Environments in Cross-Border Mergers: A Perspective from Bidders’ Earnings Management Behavior

verfasst von: Bok Baik, Kwanghee Cho, Wooseok Choi, Jun-Koo Kang

Erschienen in: Management International Review | Ausgabe 5/2015

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Abstract

This study examines the effects of targets’ institutional environments on bidders’ earning management behavior around cross-border mergers. Earnings management is a widely used strategy for the bidder to reduce the risk of overpayment and the related costs in mergers. We hypothesize that the extent to which the bidder engages in earnings management differs across the level of uncertainty resulting from the target’s institutional environments such as language, culture, religion, the quality of accounting standards, and political and legal environments. Consistent with our hypothesis, we find that the earnings management behavior of US bidders becomes more evident when they acquire targets from countries with greater institutional differences, such as non-Christian countries, countries with a low level of political stability, countries with a low level of democracy and freedom of the press and media, countries with high corruption and countries with a low level of government effectiveness. Overall, these results suggest that the bidder engages in earnings management to reduce the risk of overpayment arising from uncertainty caused by institutional differences.

Vorheriger Artikel Influence of Managerial Ownership and Compensation Structure on Establishment Mode Choice: The Moderating Role of Host Country Political Risk

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“Inverness Medical Innovations acquires German distributor, Viva Diagnostika,” Dow Jones Newswires, June 7, 2004; “Inverness Medical Innovations Announces Second Quarter 2005 Results,” Dow Jones Newswires, August 3, 2005.

The stock swap merger represents the cross-border merger with a method of financing that involves at least one share of common stock.

An exception is the literature on the inter-organizational imitation strategy of a bidder to reduce the risk and cost of cross-border mergers (Lieberman and Asaba 2006).

Besides the foreign stock acquisition, there would be others incentives for a firm to engage in earnings management. These other incentives include capital market concern and contracting such as compensation and debt contracting. Although we include relevant variables to control for these other incentives, we cannot completely rule out the possible influence of such incentives on the results of this study.

Although we do not have a formal hypothesis per each institutional variable because the institutional variables such as language, religion, culture, etc. are some representative proxies for the institutional environment of a target home country, our expectation regarding each proxy can be summarized as follows: In a stock swap cross-border merger, the bidder has more incentives to manage earnings (1) when the native language of the target is not English; (2) when the primary religion of the target is different from that of the US (i.e., not Christian); (3) when the cultural difference between the bidder and target is higher; (4) when the target has a lower quality of accounting standards; (5) when the target has a lower level of democracy and freedom of the press; (6) when the target has the lower level of political stability; (7) when the target has a higher level of corruption; and (8) when the target has a lower level of government effectiveness.

Note that this expectation has nothing to do with the superiority of languages. In other words, this argument does not mean that English is superior to other languages. We simply examine institutional differences related to languages from the perspective of US bidders.

We also use the individual Hofstede measures instead of the Kogut and Singh aggregate measure as proxies for cultural distances. The results are qualitatively the same.

Note that arguments in this section have nothing to do with the superiority of religion and culture. For instance, we do not argue that Christian countries are superior to countries with other religions. We simply examine institutional differences related to religion and culture from the perspective of US bidders whose country is classified as a Christian country.

The low quality of accounting standard indicator does not directly measure the quality of accounting disclosure per se, and rather, it represents the quality of accounting standards in one country (i.e., legislative differences among countries).

The voice and agreement index measures the extent to which the citizens of a country are able to participate in selecting their government, as well as the freedom of expression, freedom of association, and freedom of media in a country. Information on WGIs complied by the World Bank is available starting from 1996; see http://info.worldbank.org/governance/wgi/index.asp. WGIs include several indices of country risk, such as voice and agreement, political stability and absence of violence, government effectiveness, and rule of law. One advantage of using WGI measures is that these indicators have been published every other year from 1996, thereby providing time-series data useful for measuring the extent of institutional differences in the target home country.

SDC database provides data about global mergers and acquisitions from the 1970s, and the coverage is significantly improved from 1980s. It covers over 900,000 global M&A transactions from the 1970s including more than 280,000 US target and 620,000 non-US target transactions. The database arguably provides the most comprehensive coverage on the global M&As and is the most widely used in the academic study of M&As.

Abnormal accruals are also called as discretionary accruals in prior research.

Following Dechow et al. (1996), we define total accruals as follows:

\( TA_{it} = (\Delta CA{}_{it}^{{}} - \Delta CL_{it} - \Delta CASH_{it} + \Delta STD_{it} - DEP_{it} ) \)

where, for firm i at time t, TA represents total accruals, ∆CA represents change in current assets, ∆CL represents change in current liabilities, ∆CASH represents change in cash holdings, ∆STD represents change in long-term debt in current liabilities, and DEP represents depreciation and amortization expense.

The performance-matched model is the most widely used measure of earnings management in prior research. We also use alternative methods from prior studies to measure earnings management, such as Dechow and Dichev (2002), Hribar and Collins (2002) and Wysocki (2008). Our findings are robust to the various measurements of earnings management.

The mean (median) value of abnormal accruals is 0.0045 (0.0061) with the standard deviation of 0.1001. The distribution is negatively skewed (−0.2855). We use the logarithm of EM because the distribution using the logarithm is more likely to be Gaussian. The result without the logarithm is qualitatively the same as that with the logarithm, but has lower explanatory power.

We use an indicator variable for each institutional difference to facilitate the interpretation of the interaction term. The coefficient on the indicator variable is called a differential intercept coefficient and can be explained as an intercept shift between high level and low level of institutional differences.

Tender offers are generally associated with cash transactions and thus a tender offer indicator is likely to have a strong negative correlation with STOCK. In untabulated tests, we re-estimate all regressions in the tables after deleting a tender indicator variable and find that the results are unchanged.

The range for the antidirector score is zero to six, with a higher score indicating better investor protection (La Porta et al. 1998).

In our sample, non-Christian countries include China, Hong Kong, Japan, and Taiwan.

We specifically measure cultural difference as follows: CDj = ∑_i=1,2,3,4 [(I_ij − I_us)²/Vi]/4, where CDj is the cultural distance between country j and the U.S., I_ij is the country j’s score on the ith cultural dimension, Ius is the score of the U.S. on this dimension, and V_i is the variance of the score on the ith dimension (Hofstede 1980; Kogut and Singh 1988).

Given that information on WGI scores is unavailable prior to 1996, we use WGI scores in 1996 as those for the period from 1984 to 1995. The results without observations prior to 1996 are qualitatively the same.

We appreciate anonymous reviewers for suggesting this issue and encourage us to make it clear for the better interpretation of the empirical results in this study.

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Titel: The Role of Institutional Environments in Cross-Border Mergers: A Perspective from Bidders’ Earnings Management Behavior
verfasst von: Bok Baik
Kwanghee Cho
Wooseok Choi
Jun-Koo Kang
Publikationsdatum: 01.10.2015
Verlag: Springer Berlin Heidelberg
Erschienen in: Management International Review / Ausgabe 5/2015
Print ISSN: 0938-8249
Elektronische ISSN: 1861-8901
DOI: https://doi.org/10.1007/s11575-015-0249-4

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