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Earnings management, lawsuits, and stock-for-stock acquirers’ market performance
Henock Louis, Penn State University
ABSTRACT. Consistent with the notion that abnormal accruals prior to stock-for-stock merger announcements are associated with earnings management, we find a significantly positive association between a stock-for-stock acquirer’s pre-merger abnormal accruals and post-merger lawsuits. The probability of a post-merger lawsuit is also negatively associated with both the market reaction to the merger announcement and the post-merger announcement long-term abnormal returns, indicating that the market only partially anticipates the potential effects of post-merger announcement lawsuits at the merger announcement. More importantly, the evidence indicates that, not only are post-merger lawsuits potentially associated with post-merger underperformance, but they are also likely drivers of the underperformance. The evidence also suggests that the legal costs associated with pre-merger earnings management are potentially much more destructive than the direct effect of earnings management reversals.
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