Earnings management before mergers and acquisitions: Evidence from the U.S. property‐casualty insurance industry

Abstract This paper examines the earnings management behavior of target insurers before mergers and acquisitions by investigating their reserving conservatism compared to control insurers. Contrary to the expectation that acquisition targets would manipulate their earnings to increase acquisition premiums, we find that target insurers are generally more conservative in their loss reserving practices before acquisitions than control firms. This finding provides support for the effectiveness of due diligence and the contractual risk shifting arguments, and the result holds regardless of whether acquirers are insurers or non‐insurers. Furthermore, we discover that target loss reserve conservatism is negatively associated with target CEO turnover post‐acquisition. In line with existing literature, we also find evidence suggesting that targets involved in stock acquisitions tend to adopt a less conservative reserving strategy than in deals that do not include stock payments.