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Review of Accounting Studies

Erschienen in:

01.03.2015

The effect of target-firm accounting quality on valuation in acquisitions

verfasst von: Maureen F. McNichols, Stephen R. Stubben

Erschienen in: Review of Accounting Studies | Ausgabe 1/2015

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Abstract

We examine whether acquisitions are more profitable for acquirers when the firms they target disclose higher-quality accounting information. If accounting information reduces uncertainty in the value of the target firm by facilitating a more precise valuation, we predict that managers of the acquiring firm can bid more effectively and pay less to acquire a target firm that has high-quality accounting information. Using a large sample of acquisitions of public firms from 1990 to 2010, we find evidence consistent with our prediction. Specifically, when target firms have higher-quality accounting information, acquirer returns around the acquisition announcement are higher and target returns are lower—consistent with acquirers capturing a greater portion of acquisition gains by paying less for target firms. These findings, which are robust to a variety of controls and alternative measures of uncertainty and accounting quality, suggest that higher-quality accounting information leads to better bidding decisions in acquisitions.

Vorheriger Artikel Analysts’ choice of peer companies

Nächster Artikel The association between book-tax conformity and earnings management

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Although accounting researchers have applied accounting quality to various contexts, we define accounting quality as decision usefulness in the context of equity valuation (Ball and Brown 1968; Beaver 1968; Francis et al. 2008; Dechow et al. 2009).

Prior research has examined the use of accounting information by investors (Cohen 2003; Francis et al. 2005; Core et al. 2008) and by lenders (Biddle and Hilary 2006), as well as a firm’s use of its own accounting information in compensation (Peng 2007) and capital investment decisions (Biddle et al. 2008; McNichols and Stubben 2008). Our study, in contrast, focuses on one firm’s use of another firm’s accounting information when making corporate acquisition decisions.

See Palepu and Healy (2008, pp. 11–7 to 11–10) for discussion of the importance of valuing target firms to avoid overpayment.

In addition to the intuitive assessment that target accounting quality would at best be a secondary concern to acquirers when selecting among potential targets, we also added our measures of accounting quality to the acquisition prediction model of Palepu (1986). Untabulated results confirm that target accounting quality does not significantly explain the likelihood of a particular firm being acquired.

Consistent with our focus on firms’ inherent accounting quality, we employ measures of accounting quality that should be fairly immune to any earnings management that occurs just before the acquisition announcement—firm-specific accounting quality measured over several years and an industry measure of accounting quality, each of which is measured prior to the acquisition announcement date.

Hartzell et al. (2004) find evidence suggesting that CEOs of target firms benefit at the expense of shareholders. In this study, however, we focus on the incentives influencing managers of the acquiring firm.

Boone and Mulherin (2008) find that 53 % of acquisitions in their sample were negotiations and the other 47 % were auctions. Although the mechanics of these two cases differ, the general predictions are the same: overpayment by the acquirer leads to less profitable acquisitions for its shareholders. Besides, as Black (1989) notes, an auction need not be explicit; other potential bidders could bid if the first bidder’s offer is too low.

Experimental evidence suggests acquirers do not bid appropriately, even when they are given significant learning opportunities (Thaler 1988).

In contrast, Boone and Mulherin (2008), using a sample of 308 acquisitions, fails to find evidence for the winner’s curse. Their measure of target firm uncertainty is the fraction of the target firm’s assets that are not capital assets. Our study, in contrast, uses a larger sample, incorporates more comprehensive measures of target firm value uncertainty, and incorporates the effect of accounting quality on value uncertainty.

Alternatively, one could argue that targets’ returns would be higher when targets’ accounting quality is higher if better accounting information helps acquirers to identify combinations with greater synergies. The value of these synergistic gains can be split between the acquirer and the target (as determined in the negotiation or bidding process), allowing both the acquirer and the target to benefit from the target’s high-quality accounting information. However, our empirical evidence (i.e., the negative relation between accounting quality and target stock returns at the acquisition announcement) does not support this explanation. Furthermore, as noted in footnote 4, an untabulated analysis reveals that target-firm accounting quality is not a statistically significant predictor of takeover targets when added to the prediction model in Palepu (1986).

In Raman et al. (2013), the pseudo R-squared of the model explaining negotiated versus nonnegotiated deals with target accounting quality is 0.06, which suggests a substantial number of deals are likely negotiated even though target accounting quality is high, and deals are not negotiated even though target accounting quality is low.

The distinction between accounting quality and general uncertainty can be illustrated as follows. Take a firm with a variable, uncertain stream of cash flows that reflects the general uncertainty of the environment in which it operates. For example, if sales revenue is volatile, the firm may be hard to value. However, if inventory levels closely covary with future sales, then that information aids in valuation. It is easier to forecast sales revenue knowing that for every $1.00 in inventory on hand $1.20 in cash revenue can be expected the following year. However, if $1.00 in inventory is associated with $1.50 in future revenues in some years and $0.80 in others, then accounting quality is lower, and valuation is more difficult, holding general uncertainty constant. In this example, revenue volatility represents general uncertainty, and the amount of revenue volatility explained by prior-year inventory represents accounting quality.

Untabulated results support our use of a single factor—only one eigenvalue exceeds 1 (2.16; the second largest eigenvalue is only 0.48).

We require nonmissing data for at least five of the 8 years.

An alternative measure to assess acquisition profitability is the acquisition premium—the acquisition price relative to the target’s market value. However, the target’s market value directly reflects any valuation discount due to poor accounting quality, which confounds the acquisition premium measure in this setting. The acquirer’s return, instead, should reflect the net value of the acquisition to the acquirer. For example, suppose a target has an intrinsic value of $100 but trades at $93 due to a valuation discount. If an acquirer pays $110 for the deal, which is expected to produce synergies of $15, then the change in the acquirer’s value is $5 ($100 + $15 − $110). The acquisition premium ($110/[$100 − $7]), is affected by the $7 valuation discount, which should be irrelevant, and also ignores expected synergies of $15.

In addition, in our setting, long-window returns pose potential measurement issues to the extent expected returns are related to accounting quality (Francis et al. 2005).

Consistent with this idea, Baker et al. (2007) cite the result of Malmendier and Tate (2008)—that investors are more skeptical about bid announcements made by optimistic CEOs—as being consistent with irrational managers operating in efficient markets.

See Andrade et al (2001) for a review.

Our inferences are unchanged if we replace REL_SIZE with the natural log of the target’s market value in our tests or if we include both REL_SIZE and target size simultaneously.

Target accounting quality may be negatively associated with target returns for a different reason. If low accounting quality leads to a depressed stock price (i.e., through a valuation discount) and the acquirer’s bid is based on intrinsic value rather than the depressed stock price, then the lower stock price would experience a relatively larger increase upon announcement of the acquisition. Valuation discounts, however, would not confound the interpretation of the results based on acquirer returns.

We include all acquisitions of at least $1 million when analyzing target returns, but following Moeller et al. (2003), we require acquisitions of at least 10 % of the acquirer’s pre-acquisition market value when analyzing acquirer returns. This cutoff helps ensure the acquisition is material enough to be reflected in the acquirer returns.

To protect against the influence of outliers, all continuous variables are winsorized at the extreme one percentiles.

The relatively high correlations between target uncertainty and accounting quality (−0.46 and −0.37 for F_AQ and I_AQ) raise the possiblity that multicollinearity could affect the stability of the regressions. However, untabulated variance inflation factors are at or below 1.56 and 1.66 for the two regressions, which suggests the effect of multicollinearity is not substantial.

Untabulated analyses reveal similar inferences obtain when using estimates from either model (2) or model (3) individually. The coefficient on accounting quality is significantly positive as predicted in each case.

Untabulated analyses indicate that the effect of target accounting quality on acquirer returns increases with target uncertainty (t = 1.65) when target accounting quality is measured at the industry level. The interaction is not statistically significant when target accounting quality is measured at the firm level.

Although Table 2 presents the different measures of uncertainty in separate regressions, inferences are unchanged when all three uncertainty measures are included simultaneously. The coefficient on target accounting quality is significantly positive when measured at the firm level (t = 2.54) and at the industry level (t = 1.79).

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Titel: The effect of target-firm accounting quality on valuation in acquisitions
verfasst von: Maureen F. McNichols
Stephen R. Stubben
Publikationsdatum: 01.03.2015
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 1/2015
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-014-9283-x

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