Earnings management as a predictor of mergers and acquisitions withdrawal: insights from European target firms

Purpose This study investigates the effect of accrual-based and real earnings management practices on the likelihood of M&A deal withdrawal, highlighting the role of financial reporting quality in the acquirer’s decision-making. Design/methodology/approach Using a dataset of 1,611 listed nonfinancial EU target firms involved in completed or withdrawn M&A, we implement a logistic regression model to investigate the relationship between earnings manipulation and deal outcomes. Findings Our findings indicate that target firms engaging in aggressive manipulation practices through accruals, production cost and sales in the period preceding the deal announcement are significantly associated with increased deal withdrawal risk. This demonstrates acquirers’ ability to detect earnings management and incorporate this information into their decision-making process. Furthermore, the influence of earnings management on withdrawal probability remains consistent in conditions of high information asymmetry deriving from the national and industry differences, suggesting that acquirers can effectively evaluate target firms’ financial quality despite limited information. An additional analysis revealed that when target firms operate in common-law countries and regulated sectors, the impact of earnings management on deal withdrawal becomes insignificant. This finding is likely related to the limited opportunities for misleading practices in such business environments. Research limitations/implications This research focuses on publicly listed target firms, and its findings may not fully reflect the dynamics present in private firms. Furthermore, while it analyzes information asymmetry at the national level, it does not specifically address how these effects might be more pronounced in M&As between developed and emerging countries, particularly using quantifiable measures of information asymmetry. Practical implications This study emphasizes the need for acquirers to implement thorough due diligence procedures, considering both accrual and real earnings management, especially under conditions of high information asymmetry. It highlights the central role of financial reporting quality in the success of critical corporate events, such as M&As. Originality/value In contrast to previous research that primarily focused on accrual-based models, this study innovates using both accrual and real earnings management, offering a comprehensive perspective on target firms’ manipulation tactics. This aspect, combined with the selected sample, establishes an innovative approach to the topic of M&As, contributing to enhancing the current literature and providing new research avenues.