An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Paul Fischer
Penn State University

Henock Louis
Penn State University

Abstract: Prior studies have hypothesized that managers who intend to undertake a management buyout (MBO) manage earnings downward to reduce the future purchase price. We consider the hypothesis that managers also face a conflicting incentive that arises from the need to obtain the debt financing to support the MBO. The difficulty to obtain financing and the incentive to reduce their borrowing costs dampen managers’ inducement to display poor performance. We conjecture that the strength of this countervailing incentive increases in the MBO firm’s financing need and decreases in total fixed assets. Consistent with our prediction, firms that use more internal funds to finance their MBO report more negative discretionary accruals. Firms that have higher financing needs and lower total fixed assets also report higher discretionary current accruals as their managers’ reliance on external sources of funds to finance the MBOs increases.

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