Do firms that wish to be acquired manage their earnings? Evidence from major European countries

International Review of Financial Analysis 30 (2013) 57–68

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International Review of Financial Analysis

Do firms that wish to be acquired manage their earnings? Evidence from major European countries Seraina C. Anagnostopoulou, Andrianos E. Tsekrekos ⁎ Department of Accounting and Finance, Athens University of Economics and Business (AUEB), 76 Patision Str., 104 34 Athens, Greece

a r t i c l e

i n f o

Article history: Received 18 October 2012 Received in revised form 16 April 2013 Accepted 5 June 2013 Available online 12 June 2013 JEL classification: M41 G34 Keywords: Acquisition targets Seeking a buyer Takeovers Earnings management

a b s t r a c t In this paper, we examine whether findings on downward accrual-based earnings management for firms publicly ‘seeking a buyer’ from the US can be extrapolated outside of the US context, given that past research has indicated that the function of the Merger and Acquisition (M&A) markets is highly dependent on the degree of competition in a country. We test for the existence of earnings management (EM) around such events for firms listed in the largest European stock exchanges between 2000 and 2009, and get evidence that downward earnings management around ‘seeking buyer’ announcements more strongly holds for the country with the most competitive market for corporate control in our sample, that is the UK. We consider this finding indicative of the fact that a competitive M&A environment may induce earnings management-prone behavior. We further testify significantly positive abnormal returns around ‘seeking buyer’ announcements for firms from the UK, but limited such evidence for the other countries, a finding we also attribute to differences in competition and uneven split of benefits among bidders and targets in M&A markets. Finally, we find that EM positively affects abnormal returns around ‘seeking buyer’ announcements, indicating that market participants tend to compensate for upward EM, regardless of the degree of competition of the M&A market of a country. © 2013 Elsevier Inc. All rights reserved.

1. Introduction Past research has identified upward accrual-based earnings management before Mergers and Acquisitions (M&A) from the side of acquiring firms (Erickson & Wang, 1999; Louis, 2004), however, evidence on earnings management (hereafter EM) for target firms around M&A transactions has been quite context-specific. This fact is understandable upon considering that M&A targets are not normally the deal initiators, and thus may lack both the time and the opportunity to engage in any kind of EM, which would facilitate a prospective contractual outcome (Erickson & Wang, 1999). For a prospective target firm that wants to engage in a future M&A deal, a typical tactic would be to hire the services of an investment banking firm (Boone & Mulherin, 2007) to secure a potential buyer and receive relevant consulting services. What is less typical, and in a sense a very unusual M&A-related event, is for a prospective target firm to openly and publicly seek a buyer on its own initiative, by issuing a relevant announcement. Murdoch and Madura (2011) have recently examined the marketvalue consequences of publicly issuing a “seeking-a-buyer” announcement, by identifying possibly positive (e.g. no need to rely on intermediaries) and negative (target might sound ‘desperate’) consequences of

⁎ Corresponding author. Tel./fax: +30 210 8203928. E-mail address: [email protected] (A.E. Tsekrekos). 1057-5219/$ – see front matter © 2013 Elsevier Inc. All rights reserved. http://dx.doi.org/10.1016/j.irfa.2013.06.002

such a tactic. Openly seeking a buyer (hereafter SB) can be considered an ideal context for examining firm motivations to engage in accrualbased EM, given that target firms employing this unusual tactic have both the time and the opportunity to engage in such actions to affect a potential contractual outcome in their benefit: they may have the incentive to ‘window dress’ (Anilowski, Macias, & Sanchez, 2009) to attract a buyer, and therefore engage in upward EM, or, alternatively, downward EM could also represent a possibility in order to constitute a more price-attractive target. Recent US evidence (Anagnostopoulou & Tsekrekos, 2012) has indicated that SB firms on average engage in significant downward EM around the issuance of a SB announcement, pointing towards the second possibility. In this paper, we examine whether findings on downward EM for firms issuing a SB announcement are robust outside the US. This is because the function of the markets for corporate control is expected to be highly dependent on the degree of competition and shareholder protection in a particular country (Alexandridis, Petmezas, & Travlos, 2010). Potential bidders could more easily end up in overpaying in countries with highly competitive M&A markets e.g. the US or the UK, while in the less competitive markets (e.g. rest of Western Europe), the benefits of relevant transactions are more evenly split between targets and acquirers (Alexandridis et al., 2010). In this context, we expect that SB firms in more competitive environments may be more prone to engage in EM to facilitate a possible deal, resulting exactly from this high degree of competition, in comparison to firms from countries where competition in M&A markets is less intense. At the same time, the level of EM is expected to significantly differ across countries,

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depending on the degree of investor protection and the quality of local enforcement mechanisms (Leuz, Nanda, & Wysocki, 2003), making firms more or less prone to engage in EM in some countries in comparison to others (and regardless of the degree of competition in the M&A market of a given country). We test for the existence of earnings management around ‘seeking buyer’ announcements issued by firms from major European countries during 2000–2009. We focus on the UK, France, Germany, and Italy, all of which posses a satisfactory number of SB announcement firms, which makes relevant examination meaningful and intuitive. We limit our analysis to IFRS reporting firms (despite a sharp reduction in the number of observations before 2005 i.e. the year of mandatory adoption) to secure a uniform reporting environment, and we document that findings on downward EM previously observed for the US are also confirmed for the UK and Italy, but not for other countries. Our results are robust to alternative ways of measuring accrual-based earnings management, as well as to the impact of performance on the estimation of accruals. We interpret the similarity of our UK findings to previous US findings as indicative of the fact that the M&A market characteristics of the two countries are at the root of similar firm behavior around SB announcements. We further consider that the absence of significant findings for other European countries indicates that a less competitive environment in these countries does not serve as a trigger for relevant EM-prone behavior. The only country other than the UK for which evidence on EM is found is Italy, which is also a country scoring generally very highly on the EM index of Leuz et al. (2003). This last observation could imply a higher tendency for EM in an effort to guide contractual outcomes for this country in particular, despite the fact that it belongs to the pool of countries with less competitive M&A markets. Moreover, there is ample evidence that M&A target firms realize positive abnormal stock returns around the deal announcement (indicatively Alexandridis et al., 2010; Croci, Petmezas, & Travlos, 2012; Martynova & Renneboog, 2011 among others), while acquiring firms realize zero or even negative abnormal returns (Andrade, Mitchell, & Stafford, 2001; Travlos, 1987). However, the degree of competition in a country's market for corporate control has been considered a significant factor for the existence of abnormal stock returns for bidders vs. targets around M&A deal transactions (Alexandridis et al., 2010), with abnormal returns for acquiring firms to be more strongly negative, and target returns to be positive in more competitive countries, while target shareholders are found to gain significantly less, and bidders to often realize gains instead of losses in less competitive markets (see Alexandridis et al., 2010). In this context, the second scope of this paper is to test for the existence of abnormal stock returns around SB announcements for our sample countries outside of the US context, and also examine the impact of EM on market performance around SB announcements. In case targets gain more around M&A deal announcements in more rather than in less competitive countries, we expect that SB firm gains will be higher (lower) in more (less) competitive environments. This is because market participants may be anticipating that the future benefits of a potential deal may be relatively stronger (weaker) for a target firm in a more (less) completive environment. In accordance with our theoretical expectations, we find significantly positive abnormal returns around SB announcements by UK firms, but limited such evidence for SB firms from the rest of the European countries in our sample. This way, as target firms have been found by past research to gain significantly less in countries with less, as opposed to more M&A market competition, the same pattern is observed for firms wanting to become potential M&A target firms. Finally, in accordance with previous evidence for the US, we find that EM positively affects abnormal returns around SB announcements for our pooled sample of European firms. This result, although cannot be confirmed on a country by country basis due to the small size of our sample, is in accordance with past evidence for the US (Anagnostopoulou & Tsekrekos, 2012), indicating that market participants tend to compensate for upward EM regardless of the degree of competition of the M&A market in a particular country.

Overall, our findings indicate that the degree of competition in a market may be a significant contributor for market performance and earnings management by potential M&A targets, well and above actual targets of M&A transactions, assessed after a transaction has taken place. We therefore conclude that the extrapolation of any form of expected firm behavior and market reaction around M&A events based on single country evidence cannot be performed across jurisdictions before accounting for differences in competition and institutional factors. The rest of the study is organized as follows: In Section 2, we summarize the main findings of past research papers that are related to our study. Section 3 presents the theoretical discussion and offers the motivation for this study. Section 4 presents the sample selection process and outlines the methodology with respect to the measurement of earnings management and the calculation of returns. Section 5 reports a brief sample description and empirical findings, and finally the study concludes with Section 6, which summarizes the research findings. 2. Related research Despite the fact that past research has strongly indicated the existence of upward earnings management (EM) for acquiring firms in the context of M&A deals, evidence on EM for the targets of such deals has not been so clearly directional. One steam of research has provided evidence on positive, but not always significant EM for target firms (Erickson & Wang, 1999), and upward EM in the case of hostile, as opposed to friendly takeovers (Easterwood, 1998), in order to impede a possible deal. At the same time, there exists other evidence on downward EM for targets of friendly acquisitions (Ben-Amar & Missonier-Piera, 2008; Eddey & Taylor, 1999), in an effort to facilitate the conclusion of the transaction and boost financial results in the post-merger period (Ben-Amar & Missonier-Piera, 2008). The fact that evidence on targets has been quite context-dependent is understandable if one takes into account the fact that these firms are not normally the deal initiators, and thus may lack the opportunity, or time, as Erickson and Wang (1999) point out, to engage in any kind of EM which would best serve their interests in a prospective deal.1 An M&A-related event that can be characterized (at the very least) as unusual in nature, is for a firm to openly and publicly seek a buyer on its own initiative, by issuing a relevant announcement. The market-value consequences of publicly issuing a ‘seeking a buyer’ announcement (hereafter SB) have been recently studied by Murdoch and Madura (2011), who identify both positive and negative consequences of such an announcement: on the positive side, there is no need to rely on intermediaries, and the bidder may face less resistance, making the deal more attractive, but on the other hand, the target might sound ‘desperate’ or have previously failed to find a buyer through private negotiations, or potential bidders might be deterred by the fact that the bid may end up being too competitive (Murdoch & Madura, 2011). They identify a number of motives behind SB announcement, including strategic reasons, leverage, growth, or distress, but their findings indicate that overall the practice of publicly ‘seeking a buyer’ does not improve a firm's chances for attaining its goal. However, they do find evidence on significant abnormal returns around SB announcements, indicating that market participants consider the action to be in the best interest of the firm. 3. Theoretical discussion and motivation With respect to accrual-based EM in the context of firms openly SB, this setting could represent a probably ideal context for such 1 Lo (2008) underlines that the practice of EM requires the existence of both motive and opportunity, as would be the case with a crime.

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practices, as target firms have both the time and opportunity to engage in such actions in an effort to affect the contractual outcome in their benefit. One on hand, SB firms may have the incentive to ‘window dress’, following Anilowski et al.'s (2009) line of arguments, to attract a buyer. However, downward EM could also be a possibility in order to create a lower target value, facilitate the completion of a possible deal, and constitute a more price-attractive target. Recent evidence by Anagnostopoulou and Tsekrekos (2012) for US firms has indicated that SB firms engage in significant downward EM in the year of issuing a SB announcement. Their findings are consistent with implementing big-bath accounting, in an effort to signal to potential investors that ‘bad times are behind’ and the firm is ready to start over without burdens from the past (Zucca & Campbell, 1992). An alternative explanation for their findings is consistent with opportunistic motives of performing income-decreasing tactics in order to improve possibilities of attracting a buyer from a transaction point of view. They also find evidence on downward EM in the years preceding the SB announcement, but this evidence is sensitive to the impact of poor financial performance on the measurement of accruals. In this paper, we examine whether findings of significant downward EM by US firms issuing a SB announcement are robust outside the US, and test for the existence of EM around SB announcements by firms from large European countries during 2000–2009. Evidence by Alexandridis et al. (2010) has indicated that the function of markets for corporate control is highly dependent on the degree of competition and shareholder protection in a particular country. In countries where M&A markets are highly competitive and a potential bidder could easily end up in overpaying for a deal due to competition, e.g. the US or the UK, there is considerably less opportunity for acquirers to create value from the deal. For the less competitive markets, such as for the rest of Western Europe, the benefits of relevant transactions are more evenly split between targets and acquirers (Alexandridis et al., 2010). In this context, we expect that SB firms in more competitive environments could be more prone to engage in EM to facilitate a possible deal, fueled exactly by the high degree of competition, compared to firms from countries where competition is less intense. At the same time, outside of the M&A context, the general level of EM is expected to significantly differ across countries, depending on the degree of investor protection and the quality of local enforcement mechanisms (Leuz et al., 2003). Past research on the US and international markets has strongly indicated that M&A target firms realize positive abnormal returns around deal announcement dates (Alexandridis et al., 2010; Bauguess, Moeller, Schlingemann, & Zutter, 2009; Croci et al., 2012; Song & Walkling, 1993; Wansley, Lane, & Yang, 1983), while acquiring firms realize zero abnormal or even negative returns (Andrade et al., 2001; Travlos, 1987). At the same time, the degree of competition in a country has been considered a significant factor for the existence of abnormal stock returns for bidders vs. targets around M&A deal transactions (Alexandridis et al., 2010). In more competitive countries, acquiring firms have been found to realize negative abnormal returns around deal announcements, which positive abnormal returns is the case for target firms. In less competitive markets, target shareholders gain significantly less, while bidders often realize gains rather than losses (Alexandridis et al., 2010).2 In this context, the second scope of this paper is to investigate into the existence of abnormal returns around SB announcements for our sample countries outside of the US context, and further examine the impact of EM on these returns. To the extent that the pattern of the behavior of returns around M&A deals in the more competitive UK market resembles the one of US firms, we expect

2 Alexandridis et al. (2010, p. 1673) cannot discard the possibility that other differences among the countries examined might be affecting their results, however, they deduce that the level of M&A market competition in a country is a significant driver of bidder and target returns around the announcement of M&A deals, after controlling for a number factors with an ability to affect relevant returns e.g. deal, firm, legal, and institutional characteristics.

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the same kind of behavior even with respect to SB announcements. In other words, if targets gain more around M&A deal announcements in more rather than in less competitive countries, we expect that SB firm gains will be higher in more competitive environments, as market participants anticipate the future benefits of a potential deal being relatively stronger for a target firm in a more competitive environment. 4. Sample selection and the measurement of earnings management 4.1. Sample selection Our population universe starts with all firms listed in the UK, France, Germany, Italy, Austria, Spain and the Netherlands main stock exchanges (London, Paris, Frankfurt, Milan, Vienna, Madrid and Amsterdam stock exchanges respectively). We are interested in firms from this universe that, at any point in their exchange-listed corporate history, were classified by the Thomson One's M&A database as seeking a buyer (deal status: ‘Seeking Buyer’ — SB) between 2000 and 2009.3 An ‘SB status’ is defined by Thomson One as the status in which ‘the target company has announced plans to seek out a buyer or buyers for its assets or the company itself’. It is apparent from this definition that publicly announcing an intention to be acquired is a rather rare, and consequently under-researched, corporate action.4 As the focus of this study is on earnings management, we have decided to impose a first ‘strict’ selection criterion that a firm should follow the International Financial Reporting Standards (IFRS) on the year of the ‘seeking buyer’ (SB) announcement (and at least two years before that) in order to be included in the sample. This is necessary so as to accomplish a homogenization of the sample and to avoid grouping and comparing firms that follow different (domestic GAAP) accounting standards. The motivation for this selection criterion is that making use of IFRS and local standard-following firms might suffer from the limitation of attempting to detect EM among firms which do not follow the same set of accounting rules. However this necessary homogenization does result in a sharp reduction in the number of usable SB announcements for years before 2005, the year IFRS adoption became mandatory for European firms. We follow Aussenegg, Inwinkl, and Schneider (2008) and employ the accounting standard code (CAS-Code) collected from Compustat Global to distinguish between SB firms that do or do not report results following IFRS in a given year. More specifically, firms with accounting standard code (CAS-Code) DI (Domestic standards generally in accordance with IASC guidelines) and DA (Domestic standards generally in accordance with International Accounting Standards Committee (IASC) and the Organization for Economic Corporation and Development (OECD) guidelines) are classified as IFRS adopters for a given year, while firms with CAS codes DS (Domestic Standards) are considered to be local GAAP followers. Table 1 reports the number of ‘seeking buyer’ announcements by listed firms in all countries examined, before and after applying this first selection criterion. Unfortunately, just over 40% of the sample announcements survive this selection criterion. Since the surviving samples in Spain, Austria and the Netherlands are very small these countries are dropped from the analysis. Table 1 highlights the trade-off between the sample size of SB announcements and the uniformity of accounting standards we impose through our first selection criterion. In the remainder of the paper, we 3 It should be stressed that moving our start sample year further back in time (before 2000) does not make any difference as the majority of ‘seeking buyer’ announcements in the 1990s do not meet our accounting selection criteria (outlined in the next paragraph). 4 The rarity of this corporate event is highlighted by the fact that there are only 248 public such announcements by US non-financial firms (traded in NYSE, AMEX and NASDAQ) between 1990 and 2009, an average of about only 12 ‘SB announcements’ per year, as Anagnostopoulou and Tsekrekos (2012) report.

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Table 1 The table reports the number of ‘seeking buyer’ announcements by all listed firms listed in the UK, France, Germany, Italy, Austria, Spain and the Netherlands main stock exchanges (London, Paris, Frankfurt, Milan, Vienna, Madrid and Amsterdam stock exchanges respectively) between 2000 and 2009. For a firm-event to be included in the second column of the Table, the firm must have, at some point in its exchange-listed corporate history, publicly announced ‘plans to seek out a buyer or buyers for its assets or the company itself’. The third column refers to the size of a sub-sample (our main research sample), where announcements are included only if the announcing firm follows the International Financial Reporting Standards (IFRS) on the year of the ‘seeking buyer’ (SB) announcement, and at least two years before that. Country, Exchange

‘Seeking buyer’ announcements, 2000–2009

United Kingdom, London Stock Exchange France, Euronext Paris Germany, Frankfurt Stock Exchange Italy, Milan Stock Exchange Netherlands, Euronext Amsterdam Austria, Vienna Stock Exchange Spain, Madrid Stock Exchange Total

103 31 58 45 14 21 32 304

have decided to employ the IFRS-only sample (last column of Table 1 with Spain, Austria and the Netherlands dropped) as our main research sample, but we also recalculate our main results for the sample that ignores this IFRS selection criterion (middle column of Table 1 with Spain, Austria and the Netherlands again dropped) as a means of examining the robustness of our findings.5 We further require that each SB firm that remains has data available in Compustat Global for the calculation of at least one of the proxies that will be used for the detection of earnings management, as well as returns data in Datastream. Finally, in accordance with past research, we remove firms in financial sectors (SIC codes in 6000s), given that normal and abnormal accruals for the detection of earnings management are difficult to define for firms in these sectors (Zhao & Chen, 2008b). Applying these last two selection criteria results in a total of 76 ‘seeking buyer’ announcements in all four remaining countries in the IFRS-only sample, more details on which are reported in Table 2. Table 2 reports, in chronological order, the 76 companies listed in the London, Paris, Frankfurt and Milan stock exchanges that have publicly announced an intention ‘to be acquired’ between 2000 and 2009, for which the data availability criteria outlined above are satisfied. The ‘seeking buyer’ announcement date and the country of the exchange where the stocks of each firm are traded are also reported. There can be observed from Table 2 that the great majority of the SB announcements in our sample have taken place after 2005 and especially during 2007–2009 with 45 deals, and only 12 announcements by IFRS adopting firms before 2005. When it comes to the country variation of the announcements in the sample, there are 8 announcements from France, 20 from Germany, 22 from Italy, and finally, the UK is more highly represented with 26 deals. The UK has the largest and most competitive market among our sample countries (Alexandridis et al., 2010) with a corresponding stronger representation among SB firms as well; however still, the other sample countries exhibit a significant degree of representation among SB deals. 4.2. Measuring accrual-based earnings management In accordance with previous research (e.g. Erickson & Wang, 1999; Zhao & Chen, 2008a, 2008b), we test for possible EM in firms SB by examining the statistical significance of firm discretionary accruals (hereafter DA) two years before and one year after a firm seeks a buyer, as well as in the event year (i.e. the year the firm declared itself 5 We receive additional motivation for recalculating our results for all SB firms (regardless of accounting standards followed) as a robustness control by the fact that the proxies employed for the detection of accruals-based EM make use of general financial accounts such as sales, which could not be expected to be so strongly affected by the use of IFRS vs. local accounting standards. We make the results of all SB firms (IFRS and non-IFRS) available from the authors upon request. We are thankful to an anonymous referee for suggesting we focus on the IFRS sample in the main part of the paper.

Of which

‘Seeking buyer’ announcements by IFRS adopters, 2000–2009 33 13 24 29 6 8 9 122

as SB). We consider the [t − 2,t] to be a time window allowing a firm which SB to engage in actions which could help achieve specific goals, and we follow EM detection for up to year t + 1, as a given firm is not expected to be acquired immediately from the moment it declares itself as SB. We apply a number of methods in order to assess the statistical significance of discretionary accruals e.g. accruals that ‘arise from transactions made or accounting treatments chosen in order to manage earnings’, distinct from non discretionary accruals i.e. ‘accruals that arise from transactions made in the current period that are normal for the firm given its performance level and business strategy, industry conventions, macro-economic events and other factors’ (Ronen & Yaari, 2008: 372). The existence of positively significant discretionary accruals is considered to signal upward or positive EM (Erickson & Wang, 1999; Louis, 2004) i.e. an effort to ‘window dress’, while observing negatively significant discretionary accruals expected to signal the exact opposite i.e. that the firm engages in downward EM (Ben-Amar & Missonier-Piera, 2008; Eddey & Taylor, 1999), or an effort to portray an artificially worse position of the firm, in comparison to its true value. However, evidence by DeAngelo, DeAngelo, and Skinner (1994) and Kothari, Leone, and Wasley (2005) is consistent with DA being influenced by performance characteristics, rather than pure incentives to manage earnings, following specific accounting choices undertaken by managers. Furthermore, past research has underlined that existing techniques for the detection of EM i.e. isolation of the discretionary component of accruals are often biased (Kothari et al., 2005) or could suffer from misspecification errors and lack statistical power (Dechow, Hutton, Kim, & Sloan, 2012; Dechow, Sloan, & Sweeney, 1995). At the same time, SB firms represent a non-random sample, as they actively seek to participate in a distinct corporate event, with the corresponding motivation to alter their level of accruals, which is in turn used for the detection of EM. To mitigate these issues, we make use of three different model specifications in order to assess the significance of discretionary accruals for SB firms, within which we explicitly control for performance characteristics in the measurement of discretionary accruals: Model 1: Jones Model (Jones, 1991) We first estimate cross-sectionally the following regression for all years according to 2-digit SIC codes: TAi;t =Assetsi;t−1 ¼ a1 =Assetsi;t−1 þ a2 ΔRevi;t =Assetsi;t−1 þ a3 PPEi;t =Assetsi;t−1 þ εi;t where: TAi,t NIBEi,t CFOi,t

firm i's Total Accruals calculated from the Cash Flow Statement (TACFS) in year t, defined as NIBEi,t − CFOi,t; firm i's Νet Income Before Extraordinary items in year t; firm i's Cash Flows from Operations in year t;

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Assetsi,t − 1 firm i's Total Assets at the end of year t − 1; ΔRevi,t firm i's change in Revenues between year t − 1 and year t; firm i's gross value of Property, Plant and Equipment in year t; PPEi,t error term. εi,t

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argue in favor of such an inclusion, therefore but for robustness purposes we re-estimate regressions with the inclusion of a constant among our robustness controls (untabulated results available from the authors upon request). 4.3. Estimating abnormal returns

We then use the industry- and year-specific parameter estimates a^ 1 ; a^ 2 and a^ 3 to infer firm-specific discretionary accruals (DA): DAi;t ¼ TAi;t =Assetsi;t−1 −a^ 1 =Assetsi;t−1 −a^ 2 ΔRevi;t =Assetsi;t−1 −a^ 3 PPEi;t =Assetsi;t−1 :

Model 2: Modified Jones Model (Dechow et al., 1995) We first estimate cross-sectionally the following regression for all years according to 2-digit SIC codes: TAi;t =Assetsi;t−1 ¼ a1 =Assetsi;t−1 þ a2 ΔRevi;t −ΔARi;t =Assetsi;t−1 þa3 PPEi;t =Assetsi;t−1 þ εi;t where all variables as before, and firm i's change in Accounts Receivable between year t − 1 and year t.

ΔARi,t

We then use the industry- and year-specific estimates parameter estimates a^ 1 ; a^ 2 and a^ 3 to infer discretionary accruals (DA): DAi;t ¼ TAi;t =Assetsi;t−1 −a^ 1 =Assetsi;t−1 −a^ 2 ΔRevi;t −ΔARi;t =Assetsi;t−1 −a^ 3 PPEi;t =Assetsi;t−1 : In this model, we subtract the change in accounts receivable from change in revenues before model estimation, following Kothari et al. (2005) and DeFond and Park (1997). Model 3: ROA-Adjusted Model (Kothari et al., 2005) We first estimate cross-sectionally the following regression for all years according to 2-digit SIC codes: TAi;t =Assetsi;t−1 ¼ a1 =Assetsi;t−1 þ a2 ΔRevi;t −ΔARi;t =Assetsi;t−1 þa3 PPEi;t =Assetsi;t−1 þ a4 ROAi;t þ εi;t

In this section, we describe the calculation of Cumulative Abnormal Returns (CARs), which will be used in our subsequent tests on the market performance of SB firms in the days around the SB announcement, as well as when we examine the impact of EM on the market performance of SB firms around the event. Following previous studies examining the market impact of SB announcements for the US (Murdoch & Madura, 2011), we make use of their methodology to estimate cumulative abnormal stock returns over [– k, + k] days around the announcement day (day 0) for each ‘seeking buyer’ firm (the ‘event period’). Data for firm stock returns as well as for the corresponding country stock exchange main index have been extracted from Datastream. Using daily total returns [– l, − 31] days before the announcement as the ‘estimation period’, we perform market model regressions Ri;t ¼ ai þ bi Rm;t for each SB firm i, where Ri,t is the return of SB firm i on day t and the return of the corresponding country market index on day t is used as the market proxy m. The FTSE100 index, the CAC40 index, the DAX index and the FTSE MIB 40 are used as market proxies for the United Kingdom, France, Germany and Italy respectively. Given estimates a^ i ; b^ i for each SB firm in the estimation period, we calculate firm i abnormal returns (ARi) and cumulative abnormal returns (CARi) via   ARi;t ¼ Ri;t − a^ i þ b^ i Rm;t

−k;þk

and CARi

þk

¼ ∑t¼−k ARi;t :

We then report average cumulative abnormal returns, ACAR−k;þk ¼ across all SB firms in a given country (and across all countries), for k = 0, 1, 5, 10 and l = 240, 340. The statistical significance of ACAR is assessed by employing the standardized cross- sectional z statistic (SCS z-stat) of Boehmer, Musumeci, and Poulsen (1991), which accounts for event-induced changes in return variance, in accordance with the theoretical arguments of Higgins and Peterson (1998). −k;þk N 1 N ∑i¼1 CARi

where firm i's Total Accruals calculated from the Cash Flow Statement (TACFS) in year t, defined as NIBEi,t − CFOi,t; firm i's Return on Assets, calculated as NIBEi,t/Assetsi,t − 1 ROAi,t and all other variables as before. We then use the industry- and year-specific estimates parameter estimates a^ 1 ; a^ 2 ; a^ 3 and a^ 4 to calculate discretionary accruals (DA):

5. Empirical findings

TAi,t

DAi;t

¼ TAi;t =Assetsi;t−1 −a^ 1 =Assetsi;t−1 −a^ 2 ΔRevi;t −ΔARi;t =Assetsi;t−1 −a^ 3 PPEi;t =Assetsi;t−1 −a^ 4 ROAi;t :

Cross-sectional regression estimation for the detection of accrualsbased earnings management follows from previous literature (e.g. DeFond & Jiambalvo, 1994; Subramanyam, 1996). We impose a minimum of 8 observations for each yearly cross-sectional regression run for firms in the same 2-digit SIC code (which also have to follow IFRS for a given year), as in Francis, LaFond, Olsson, and Schipper (2005) and Zhao and Chen (2008b). We follow Ball and Shivakumar (2006) and Zhao and Chen (2008b) who do not use a true constant term in the cross-sectional regressions (other than the term of a constant scaled by lagged total assets). However, as Kothari et al. (2005)

5.1. Earnings management around SB announcements For our sample of firms listed in the London, Paris, Frankfurt and Milan stock exchanges that have issued a ‘seeking buyer’ announcement between 2000 and 2009 (and satisfy our sample selection criteria in Section 4.1), we first report in Table A.1 (relegated in the Appendix A) some useful descriptive statistics of the control variables that are used in the empirical analysis later on. Year t stands for the fiscal year during which the firms publicly announced that an acquirer is sought. Panel A reports descriptive statistics of variables aggregated across all countries/markets, while Panel B provides statistics for each country/market separately. TACFSti stand for total accruals, estimated from the cash flow statement, ΔREVi/TAi stands for the annual change in revenues, divided by lagged total assets, while Ln(TAi) is the natural logarithm of total assets. ROAi is the return on assets, estimated as net income before extraordinary items divided by lagged total assets. On aggregate, it can be observed from Panel A of Table A.1 in the Appendix A that the majority of sample firms (approximately 79% of them) experience positive ROAs in the fiscal year the SB announcement is made, while sample firms appear almost equally split when it comes

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Table 2 The table reports, in chronological order, the 76 companies listed in the London, Paris, Frankfurt and Milan stock exchanges that have publicly announced an intention ‘to be acquired’ between 2000 and 2009, for which the study data availability criteria are satisfied. The ‘seeking buyer’ announcement date and the country of the exchange where the stocks of each firm are traded are also reported. Company

Announcement date

Country/Market

Company

Announcement date

Country/Market

DAIMLER AG AIR FRANCE — KLM INTERSHOP COMMS AG INFINEON TECHNOLOGIES CINEMAXX AG HOCHTIEF AG ENI SPA RICHARD GINORI 1735 SPA RHEINMETALL AG MINERALBRUNNEN AG BILFINGER BERGER AG RATTI SPA OXFORD BIOMEDICA LTD UK COAL PLC MEDIASET SPA UBI SOFT ENTERTAINMENT THALES NORTHGATE PLC BEIERSDORF AG PRAKTIKER BAU & HEIMWERKER H RIZZOLI CORRIERE DELLA SERA PANDATEL AG BRITVIC PLC ADVA AG OPTICAL NETWORKING HOLIDAYBREAK PLC TOP TEN HOLDINGS PLC D1 OILS PLC UBC MEDIA GROUP PLC SECHILIENNE SEVERN TRENT PLC SSL INTERNATIONAL PLC FORMATION GROUP PLC SPORTECH PLC CONTENTFILM PLC BEATE UHSE AG SANOFI-AVENTIS SEAT PAGINE GIALLE SPA PENNON GROUP PLC

06/25/2002 12/19/2002 07/15/2003 01/12/2004 01/29/2004 02/16/2004 05/06/2004 07/13/2004 08/07/2004 08/27/2004 09/18/2004 10/28/2004 01/20/2005 04/07/2005 04/13/2005 05/26/2005 06/10/2005 09/12/2005 09/19/2005 10/04/2005 10/18/2005 11/18/2005 12/13/2005 02/14/2006 03/20/2006 04/16/2006 06/05/2006 06/27/2006 07/12/2006 10/15/2006 12/06/2006 02/14/2007 03/07/2007 03/15/2007 04/02/2007 05/12/2007 05/22/2007 05/24/2007

GER FR GER GER GER GER ITA ITA GER GER GER ITA UK UK ITA FR FR UK GER GER ITA GER UK GER UK UK UK UK FR UK UK UK UK UK GER FR ITA UK

CENTRICA PLC DEBENHAMS PLC TELECOM ITALIA MEDIA SPA ABCAM TV LOONLAND AG SNAI SPA SAGE GROUP PLC MORRISON (WM) SUPERMARKETS ITV PLC PIRELLI & CO FIAT SPA ERG SPA MITCHELLS & BUTLER PLC TISCALI SPA L'AIR LIQUIDE SA AS ROMA QINETIQ GROUP FLYING BRANDS LTD LINDE AG CURANUM AG REDROW PLC EDISON SPA PININFARINA SPA HEIDELBERGER DRUCKMASCHINEN INDESIT CO SPA VEOLIA ENVIRONNEMENT CONTINENTAL AG KAESSBOHRER GELAENDEFAHRZEUG IT HOLDING SPA KAMPA AG ENEL SPA NEXT FIFTEEN COMMUNICATIONS CANAL PLUS SA SNAM RETE GAS SPA ARKIMEDICA SPA ASTRAZENECA PLC ACEA SPA ATLANTIA SPA

06/17/2007 07/02/2007 07/17/2007 07/27/2007 08/23/2007 09/04/2007 09/19/2007 09/21/2007 10/03/2007 10/17/2007 12/08/2007 03/12/2008 03/16/2008 04/03/2008 06/03/2008 06/20/2008 06/30/2008 08/07/2008 08/20/2008 10/27/2008 11/09/2008 11/10/2008 12/04/2008 01/22/2009 01/26/2009 01/28/2009 02/11/2009 02/14/2009 03/12/2009 03/20/2009 03/26/2009 05/11/2009 05/13/2009 07/14/2009 09/21/2009 09/28/2009 10/03/2009 10/15/2009

UK UK ITA UK GER ITA UK UK UK ITA ITA ITA UK ITA FR ITA UK UK GER GER UK ITA ITA GER ITA FR GER GER ITA GER ITA UK FR ITA ITA UK ITA ITA

to positive (52%) and negative (48%) changes in revenues in the same year. In the country by country results of Panel B, we consistently observe more positive than negative event-year ROAs in all sample countries, while the average change in revenues is negative for sample firms from Germany and Italy, but not for sample firms from the UK and France, which exhibit average positive changes in revenues. Table 3 reports the average, median and standard deviation of discretionary accruals of companies listed in the London, Paris, Frankfurt and Milan stock exchanges that have publicly announced an intention ‘to be acquired’ between 2000 and 2009, for which the study data availability criteria are satisfied. The models used to distinguish the discretionary and non-discretionary components of accruals appear in the second column. Panel A reports results aggregated across all countries/markets, while Panels B–E provides results for each country/market separately. We observe from Table 3 Panel A that SB firms for our sample countries as a whole exhibit significantly negative discretionary accruals for up to two years before the SB announcement, and also in year t. This result holds for mean and median DA under all three model specifications, and also holds for the Kothari et al. (2005) ROA-adjusted model, with the exception of median DA as of the year of the announcement. Results for means are generally significant at 1% significance level in most cases, and show significance at 5% in the case of medians. When it comes to repeating the analysis on a country by country basis in Panels B–E, evidence on downward EM for the year of the SB announcement are confirmed for the UK and

Italy when using means, but not for France and Germany. Results are strongest in the case of Italy, for which evidence on negative EM steadily holds for up to two years before the announcement, in many cases when using medians as well whereas relative evidence for year t-1 do not hold for the UK. As a robustness control, we further calculated the relevant results on DA around SB announcements as of Table 3, this time re-calculated by making use of all firms in a given industry (and corresponding SB firms), regardless of whether they follow IFRS or local accounting standards (untabulated results, reported in a previous version of the paper, available upon request). Results remained qualitatively similar, with a corresponding increase in the number of observations, confirming our findings of Table 3 on the IFRS-only SB firms. Taking the findings of Table 3 as a whole, we observe evidence of significant downward EM for our four-country sample of European firms publicly seeking a buyer, in accordance with previous evidence for US firms (Anagnostopoulou & Tsekrekos, 2012). The rationale for such downward accrual manipulation may first relate to a possible motivation for a firm to make itself a more ‘price attractive’ target. An alternative explanation would be the implementation of big bath accounting by SB firms, in an effort to signal to potential investors the message that bad times are over. When we repeat our analysis on a country by country basis, we observe that our results for the entire sample are primarily driven by results from the UK and Italy as we get no evidence on significant DA for SB firms from Germany and France. In the case of the UK, evidence is understandable upon

Table 3 The table reports the average, median and standard deviation of discretionary accruals of companies listed in the London, Paris, Frankfurt and Milan stock exchanges that have publicly announced an intention ‘to be acquired’ between 2000 and 2009, for which the study data availability criteria are satisfied. The models used to distinguish the discretionary and non-discretionary components of accrual appear in the second column. The models are estimated on industry data (two-digit SIC code) as described in Section 4.2, by imposing a minimum of 8 observations per SIC code/year for firms following IFRS. Panel A reports results aggregated across all countries/markets, while Panels B–E provide results for each country/market separately. N stands for the number of firms with all data available in a given fiscal year and year t is the fiscal year during which the firms publicly announced that an acquirer is sought. An *, ** and *** indicate that a t-test for the mean is statistically significant at 10%, 5% and 1% level of significance respectively. An †, †† and ††† indicate that a z-test for the median (Wilcoxon signed rank test) is statistically significant at 10%, 5% and 1% level of significance respectively.

No.

t-2 Name

N

Panel A: All countries/markets 1 Jones 53 TACFS 2 Modified Jones 53 TACFS 53 Kothari et al. 3 TACFS

t-1

t

t+1

Mean

St Dev

Median

N

Mean

St Dev

Median

N

Mean

St Dev

Median

N

Mean

St Dev

Median

−0.0480***

0.1309

−0.0270††

61

−0.0194*

0.0815

−0.0212††

69

−0.0252***

0.0801

−0.0042†

66

−0.0308***

0.0976

−0.0237††

−0.0473***

0.1215

−0.0270††

61

−0.0196**

0.0776

−0.0214††

69

−0.0255***

0.0797

−0.0058†

66

−0.0353***

0.0954

−0.0302†††

−0.0450***

0.1073

−0.0286††

60

−0.0188*

0.0866

−0.0170†

68

−0.0299***

0.0784

−0.0085

65

−0.0213

0.1129

−0.0242††

−0.0448†††

17

0.0019

0.0734

0.0196

22

−0.0418*

0.1051

−0.0070

26

−0.0126

0.0840

−0.0088

−0.0423†††

16

−0.0008

0.0741

0.0033

21

−0.0454**

0.0978

−0.0120

25

−0.0262*

0.0744

−0.0160

−0.0316†††

17

−0.0180

0.0763

−0.0002

22

−0.0527***

0.1016

−0.0172†

26

−0.0072

0.1321

−0.0212†

Germany 0.1177

0.0085

19

−0.0236

0.0834

−0.0259

20

−0.0075

0.0719

0.0006

17

−0.0144

0.1360

−0.0182†

0.1158

0.0097

19

−0.0250

0.0909

−0.0303

20

−0.0072

0.0637

0.0079

17

−0.0103

0.1365

−0.0199†

0.0765

−0.0034

19

0.0038

0.0962

−0.0007

20

−0.0081

0.0568

0.0016

17

0.0161

0.1072

−0.0113

−0.0559†††

17

−0.0514***

0.0872

−0.0302†††

19

−0.0207*

0.0464

−0.0089

17

−0.0771***

0.0660

−0.0705†††

−0.0560†††

17

−0.0429***

0.0705

−0.0222††

19

−0.0212**

0.0470

−0.0094†

17

−0.0786***

0.0673

−0.0720†††

−0.0286††

17

−0.0534***

0.0867

−0.0215††

19

−0.0239**

0.0512

−0.0092†

17

−0.0740***

0.0751

−0.0692†††

−0.0510†††

8

0.0134

0.0675

0.0008

8

−0.0342

0.0876

0.0014

6

−0.0251

0.0738

−0.0061

−0.0452†††

8

0.0050

0.0586

0.0000

8

−0.0295

0.0935

−0.0037

6

−0.0218

0.0812

−0.0036

−0.0349†††

8

0.0042

0.0553

0.0008

8

−0.0286

0.0933

−0.0023

6

−0.0356

0.0754

−0.0222††

Panel B: Firms listed in the London stock exchange, UK 1 Jones 10 −0.0434*** 0.0562 TACFS 2 Modified Jones 10 −0.0437*** 0.0585 TACFS 3 Kothari et al. 10 −0.0442*** 0.0532 TACFS Panel C: Firms listed in the Frankfurt stock exchange, 1 Jones 19 −0.0157 TACFS 2 Modified Jones 19 −0.0197 TACFS 3 Kothari et al. 19 −0.0168 TACFS

Panel D: Firms listed in the Milan stock exchange, Italy 1 Jones 17 −0.0514*** 0.0554 TACFS 2 Modified Jones 17 −0.0500*** 0.0460 TACFS 3 Kothari et al. 17 −0.0511*** 0.0747 TACFS Panel E: Firms listed in the Paris stock exchange, France 1 Jones 7 −0.1344 0.2862 TACFS 2 Modified Jones 7 −0.1205 0.2611 TACFS 3 Kothari et al. 7 −0.1078 0.2362 TACFS

S.C. Anagnostopoulou, A.E. Tsekrekos / International Review of Financial Analysis 30 (2013) 57–68

Year Model

63

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S.C. Anagnostopoulou, A.E. Tsekrekos / International Review of Financial Analysis 30 (2013) 57–68

considering that this country represents a competitive M&A market, as is the case with the US, with corresponding repercussions for the degree of competition a potential target would face in such a market. In that case, SB firms may feel they will face higher competition than a potential target would face in a less competitive market like the rest of the countries in our sample, and thus engage in EM as our findings indicate. The only country for which we find evidence on EM among our less competitive markets (according to the Alexandridis et al., 2010 classification) is Italy. Italy, however, is also a country which has scored highly in Leuz et al.'s (2003) cross-country comparative study on EM. This way, our findings for Italy could imply a higher tendency for EM in an effort to affect the fate of a potential deal for this country in particular, despite the

fact that it belongs to the pool of countries with less competitive M&A markets. 5.2. Market performance around the SB announcements We then report in Table 4, for different event periods (1, 5 and 10 days) around the SB announcement day (day 0), average cumulative abnormal returns (ACAR) across SB companies listed in the London, Paris, Frankfurt and Milan stock exchanges between 2000 and 2009, satisfying the sample availability criteria (the IFRS-only sample). Table 4 Panel A reports ACAR aggregated across all countries/markets, while Panels B–E provide results for each country/market separately. In all Panels, firm and market returns [− 240,− 31] and

Table 4 The table reports, for different event periods around the announcement day (day 0), average cumulative abnormal returns (ACAR) across companies listed in the London, Paris, Frankfurt and Milan stock exchanges that have publicly announced an intention ‘to be acquired’ between 2000 and 2009, for which the study data availability criteria are satisfied. Panel A reports ACAR aggregated across all countries/markets, while Panels B–E provide results for each country/market separately. In all Panels, firm and market returns [−240,− 31] and [−340,−31] days prior to the announcement day respectively, are used in order to estimate the market model parameters, for inferring event-period firm abnormal returns. The standardized cross-sectional z statistic (SCS z-stat) of Boehmer et al. (1991), which accounts for event-induced changes in return variance, is used in determining the statistical significance of ACAR. An *, ** and *** indicate that the null hypothesis of a zero average is rejected at the 10%, 5% and 1% level of significance respectively. Pre-announcement event period Panel A: All countries/markets Estimation period is [−240,−31] days prior the announcement day (day 0) ACAR SCS z-stat Estimation period is [−340,−31] days prior the announcement day (day 0) ACAR SCS z-stat Panel B: Firms listed in the London stock exchange, UK Estimation period is [−240, −31] days prior the announcement day (day 0) ACAR SCS z-stat Estimation period is [−340, −31] days prior the announcement day (day 0) ACAR SCS z-stat

[−10,0]

[−5,0]

[−5,+5]

[−1,+1]

[−1,0]

[0,+1]

[0,+5]

[0,+10]

0.0079 0.29

−0.0018 −0.06

0.0122 1.48

0.0052 1.18

0.0142** 2.33

0.0118** 2.27

0.0036 0.41

−0.0058 −0.50

−0.0085 −0.75

0.0095 0.34

−0.0007 −0.02

0.0131 1.51

0.0055 1.19

0.0141** 2.32

0.0120** 2.30

0.0032 1.36

−0.0065 −0.56

−0.0090 −0.80

0.0538*** 2.97

0.0583*** 3.14

0.0457** 2.33

0.0580*** 2.64

0.0336** 2.39

0.0258* 1.82

0.0183** 2.01

0.0229** 2.04

0.0151 0.36

0.0574*** 3.16

0.0642*** 3.61

0.0473** 2.38

0.0608*** 2.72

0.0340** 2.38

0.0261* 1.84

0.0186** 1.97

0.0241** 2.10

0.0174 0.56

Panel C: Firms listed in the Frankfurt stock exchange, Germany Estimation period is [−240, −31] days prior the announcement day (day 0) ACAR −0.0567 SCS z-stat −0.70 Estimation period is [−340, −31] days prior the announcement day (day 0) ACAR −0.0566 SCS z-stat −0.74

−0.0664 −0.69

−0.0441 −0.74

−0.0547 −0.70

−0.0008 −0.44

−0.0089 −0.79

−0.0059 −0.36

−0.0246 −0.68

−0.0237 −0.72

−0.0675 −0.78

−0.0439 −0.73

−0.0562 −0.75

−0.0008 −0.41

−0.0085 −0.73

−0.0063 −0.37

−0.0262 −0.83

−0.0249 −0.86

−0.0235 −0.73

0.0145 0.84

0.0024 0.32

0.0074 0.66

0.0059 0.65

0.0002 0.03

−0.0135 −0.56

−0.0235 −0.70

−0.0215 −0.65

0.0163 1.02

0.0029 0.42

0.0075 0.75

0.0065 0.73

−0.0004 0.00

−0.0148 −0.63

−0.0251 −0.73

0.0824 0.89

0.0667 0.97

0.0693 1.24

0.0364 1.14

0.0183* 1.86

0.0427 1.23

−0.0015 0.22

−0.0100 −0.09

0.0073 1.03

0.0694 0.88

0.0530 0.97

0.0606 1.28

0.0306 1.29

0.0149** 1.99

0.0372 1.23

−0.0025 0.15

−0.0102 −0.06

0.0034 0.92

Panel D: Firms listed in the Milan stock exchange, Italy Estimation period is [−240, −31] days prior the announcement day (day 0) ACAR −0.0014 SCS z-stat −0.45 Estimation period is [−340, −31] days prior the announcement day (day 0) ACAR 0.0022 SCS z-stat −0.29 Panel E: Firms listed in the Paris stock exchange, France Estimation period is [−240, −31] days prior the announcement day (day 0) ACAR SCS z-stat Estimation period is [−340, −31] days prior the announcement day (day 0) ACAR SCS z-stat

[−10,+10]

S.C. Anagnostopoulou, A.E. Tsekrekos / International Review of Financial Analysis 30 (2013) 57–68

[− 340,− 31] days prior to the announcement day respectively, are used in order to estimate the market model parameters, for inferring event-period firm abnormal returns, following the methodology reported in Section 4.3. The standardized cross-sectional z statistic (SCS z-stat) of Boehmer et al. (1991), which accounts for eventinduced changes in return variance, is used in determining the statistical significance of ACAR. There can be observed from Table 4 Panel A that SB firms on average exhibit significantly positive abnormal returns at 5% significance level in the one-day window around the SB announcement (window of [− 1 + 1] days and also [− 1,0] days), in accordance with previous US evidence (Murdoch & Madura, 2011; Anagnostopoulou & Tsekrekos, 2012). This way, evidence on positive abnormal returns for M&A targets around M&A deal announcements is also confirmed for potential targets. When repeating the analysis on a country by country basis in Table 4 Panels B–E, evidence on positive and significant ACARs is confirmed for the UK in Panel B, for which relevant findings are actually stronger than in Panel A, in terms of statistical significance at 1% in many cases, and also hold for almost every time window examined (but for the [0, +10] time window). However, there is no evidence of significant stock return performance

65

for either Germany or Italy for any of the time windows examined. In the case of France, there is evidence on significant ACARs only for the time window of [−1, +1] day around the announcement, at 10% or 5% level, depending on the methodology employed to estimate ACARs. Overall, we report of significant positive excess returns for SB firms in the UK, but no such evidence for the rest of the sample countries, with the weak exception of France for the one day time window around the announcement. Evidence for SB firms from the UK conforms past results for the US, which is considered to constitute a competitive M&A market, as is the case for the UK (Alexandridis et al., 2010), but findings for the rest of the sample countries, which have been characterized as less competitive M&A markets, do not confirm US evidence. In this context, we consider that (a) past evidence on significantly positive market performance for M&A deal targets around announcements by firms operating in countries with competitive M&A markets, and (b) weaker evidence on positive market performance for relevant targets from less competitive markets are both also confirmed in the case of SB firms. As these firms publicly declare their intention to become a potential M&A deal target, in less competitive environment, investors should

Table 5 The table reports the estimation results of the pooled regression CARi = δ0 + δ1ROAi + δ2Ln(TAi) + δ3(ΔREVi/ΤΑi) + δ4DAi + ∑j = {London,Paris,Frankfurt}ζjSEDij + ei. The dependent variable CARi is the cumulative abnormal return of firm i around the ‘seeking buyer’ announcement day. ROAi is the return on assets of firm i, calculated as net income before extraordinary items, divided by lagged total assets, while Ln(TAi) is the natural logarithm of firm's i total assets. (ΔREVi/TAi) is the firm's change in revenues, over total assets. DAi stands for the firm's discretionary accruals calculated via the Kothari ROA-matched model. SEDi,j is a stock exchange dummy that takes the value of one if the shares of firm i that is publicly announcing it is ‘seeking a buyer’ are traded in the stock exchange j, and zero otherwise with j = {London, Paris, Frankfurt}. The Milan stock exchange dummy is the eliminated variable in the estimation. All independent variables are as of year t (the year of the ‘seeking buyer’ announcement), and t-statistics are reported in parentheses. Firm and market returns [−240,−31] days prior to the announcement day respectively, are used in order to estimate the market model parameters, for inferring event-window firm abnormal returns. In Panel A (respectively B) the stock exchange dummies SEDi,j are excluded from (respectively included in) the estimation. In specifications (4)–(6) return on assets ROAi are excluded from the regression. An *, ** and *** indicate statistical significance at the 10%, 5% and 1% level respectively. Dependent var.

(1)

(2)

(3)

(4)

(5)

(6)

CAR [−1,+1]

CAR [−1,0]

CAR [0,+1]

CAR [−1,+1]

CAR [−1,0]

CAR [0,+1]

Panel A: Stock exchange dummies SEDi,j excluded from estimation Intercept 0.0240 −0.0018 (0.47) (−0.04) −0.0032*** −0.0020*** ROAi (−3.23) (−2.41) −0.0003 0.0024 Ln(TAi) (−0.05) (0.42) 0.0547 0.0526 (ΔREVi/TAi) (1.30) (1.00) 0.3063** 0.2232** DAi (As of year t) (2.10) (1.97) 0.2510 0.1289 R2 F 5.37*** 3.16** No. Obs. 62 62

0.0104 (0.24) −0.0013 (−0.85) 0.0001 (0.01) 0.0152 (0.30) 0.2477** (2.13) 0.0967 1.30 62

0.06787 (1.25)

0.0253 (0.54)

0.0277 (0.58)

−0.0062 (−1.03) 0.0242 (0.83) 0.2804** (2.07) 0.0854 2.66** 62

−0.0012 (−0.23) 0.0339 (0.76) 0.2072* (1.86) 0.0457 1.90 62

−0.0023 (−0.43) 0.0031 (0.08) 0.2374** (2.18) 0.0583 1.77 62

Panel B: Stock exchange dummies SEDi,j included in estimation Intercept 0.0236 0.0016 (0.52) (0.04) −0.0037*** −0.0024*** ROAi (−3.31) (−2.90) 0.0002 0.0020 Ln(TAi) (0.04) (0.37) 0.0408 0.0323 (ΔREVi/TAi) (0.97) (0.61) 0.3248** 0.2125* DAi (As of year t) (2.22) (1.76) 0.0285 0.0229 SEDi,j j = London (1.27) (1.00) −0.0008 0.0295 SEDi,j j = Paris (−0.03) (0.82) −0.0314 −0.0288 SEDi,j j = Frankfurt (−1.12) (−1.24) R2 0.3150 0.2062 F 3.28*** 2.90** No. Obs. 62 62

0.0070 (0.16) −0.0016 (−0.98) 0.0005 (0.11) 0.0063 (0.12) 0.2608** (2.23) 0.0202 (1.18) −0.0015 (−0.07) −0.0154 (−0.64) 0.1296 1.02 62

0.0725 (1.45)

0.0337 (0.76)

0.0275 (0.60)

−0.0064 (−1.09) 0.0158 (0.51) 0.2927** (2.09) 0.0145 (0.63) −0.0058 (−0.28) −0.0192 (−0.68) 0.1073 1.57 62

−0.0023 (−0.47) 0.0159 (0.35) 0.1915 (1.62) 0.0137 (0.58) 0.0262 (0.74) −0.0207 (−0.93) 0.088 0.96 62

−0.0022 (−0.43) −0.0042 (−0.10) 0.2473** (2.25) 0.0143 (0.92) −0.0036 (−0.20) −0.0103 (−0.42) 0.0753 1.33 62

66

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be aware that a potential bidder will not probably end up paying such a large premium as would be the case in a more competitive market (Alexandridis et al., 2010, for M&A deal target firms from competitive vs. less competitive countries). This way, the potential from transfer of wealth between a potential bidder and the potential target SB will not be as large in a less competitive market, and the result is the lack of existence of significant abnormal market performance in SB firms from less competitive markets in the days around the announcement. However, for more competitive markets, such as the US and the UK, the possibility for a bidder to overpay and end up in transferring wealth to a potential target is higher, with a corresponding positive influence on the SB firms (or potential M&A deal target) abnormal returns upon a SB intention is declared.

deficiencies, and this latter finding is observed to hold when making use of either evidence from Europe or the US, i.e. no matter how strong the competition in an M&A market may be. Results from Table 5 are robust to the inclusion of country dummy variables, which provide reassurance on the possibility to generalize them, despite the fact that Eq. (1) is estimated for a pooled four country sample, and the fact that previous findings from Table 3 indicated that the amount of EM for SB firms may differ depending on the context examined each time. Finally, the only independent variable other than DA which shows signs of significance is the ROA variable. The latter is found to negatively relate to abnormal returns around SB announcements, an indication that the market may react more positively to SB announcements by firms which are operationally weaker, thus compensating for their decision to enhance their future business prospects by SB.

5.3. Earnings management and market performance around SB announcements

6. Conclusion

We next examine the impact of potential EM on the market performance of SB firms in the days around SB announcements. The following equation is estimated for the pooled sample of SB firms from the four sample countries during 2000–2009:  CARi ¼ δ0 þ δ1 ROAi þ δ2 LnðTAi Þ þ δ3 þ

∑

ΔREVi TAi

 þ δ4 DAi

ð1Þ

ζ j SEDij þei : j¼fLondon;Paris;Frankfurt g

The dependent variable CARi is the cumulative abnormal return of firm i around the ‘seeking buyer’ announcement day (time windows [− 1,+1], [− 1,0], [0, + 1]). The one day window is selected as this represents the time period for which results are strongest for our SB firms on Table 4, and at the same time when it represents the time window which is closest to the event. ROAi is the return on assets of firm i, calculated as net income before extraordinary items, divided by lagged total assets, while Ln(TAi) is the natural logarithm of firm's i total assets. (ΔREVi/TAi) is the firm's change in revenues, over total assets. DAi stands for the firm's discretionary accruals calculated via the Kothari ROA-matched model. SEDi,j is a stock exchange dummy that takes the value of one if the shares of firm i that is publicly announcing it is ‘seeking a buyer’ are traded in the stock exchange j, and zero otherwise with j = {London, Paris, Frankfurt}. The Milan stock exchange dummy is the eliminated variable in the estimation. All independent variables are as of year t (the year of the ‘seeking buyer’ announcement), and t-statistics are reported in parentheses. We estimate several versions of Eq. (1), by including and excluding the stock exchange dummies SEDi,j and the return on assets ROAi from the regression, the latter mainly for robustness purposes to mitigate for the impact of possibly double-controlling for the effect of performance on returns, given that DA included among regressors have been calculated according to the Kothari et al. (2005) performance adjustment to the Modified Jones model. As the number of observations is quite small, we attempt to keep our regression model as parsimonious as possible. Table 5 reports estimation results for all versions of Eq. (1). We observe from Table 5 that discretionary accruals positively relate to ACARs in the day around the SB announcement, in accordance with previous findings for the US (Anagnostopoulou & Tsekrekos, 2012). This indicates that despite the fact that, on average, SB firms are found to engage in downward EM around SB announcement, at least in the UK and Italy, results from Table 5 imply that market reaction is not actually favorable for firms engaging in such a practice. To the extent that SB firms not engaging in downward EM are the firms with fewer operating problems at the root of their motivation to issue a SB announcement, then evidence indicates that market participants compensate mostly firms which are not subject to very strong operating

In this paper, we examine whether findings of downward EM by firms issuing a SB announcement testified for US are robust outside of the US context, given that past research has indicated that the function of markets for corporate control is highly dependent on the degree of competition and shareholder protection in a particular country. We test for the existence of EM around SB announcements by exchange-listed firms from four large European countries, the UK, France, Germany, and Italy, during 2000–2009. The UK has been considered a highly competitive M&A market, with a relatively high number of deals taking place, whereas the level of competition in the markets for corporate control is lower for the rest of our sample countries. We find that evidence of downward EM previously reported for the US is also confirmed for the UK, and for Italy, but not for other countries. We consider that the similarity of our UK findings to previous US evidence is indicative of the fact that the M&A market characteristics of the two countries are probably causing similar firm behavior around SB announcements. In other words, the presence of a competitive M&A environment may serve as a trigger for EM-prone corporate behavior, which is observed among firms SB in more competitive environments, such as the US and the UK, but not for markets with less competition. The only country other than the UK for which evidence on EM is found is Italy. However, this is also a country which has been linked by past research to comparatively stronger EM practices, a fact we consider to be possibly implicative of a higher tendency for EM in an effort to guide contractual outcomes for this country in particular, despite the fact that it belongs to the pool of countries with less competitive M&A markets. We further testify significantly positive abnormal returns around SB announcements for firms from the UK, but limited such evidence for firms from the other sample countries in our sample. We interpret this finding as follows: as M&A target firms have been found by past research to gain significantly less in countries with less, as opposed to more competition in M&A markets, we observe the same pattern of return behavior for firms wanting to become potential M&A targets, i.e. ‘seeking buyer’ firms. This way, we find significant evidence of abnormal performance for SB firms from more, as opposed to less competitive M&A environments. Finally, confirming previous evidence for the US, we find that EM positively affects abnormal returns around SB announcements. This aggregate result, which cannot be confirmed on a country by country basis due to small sample sizes, is in accordance with past evidence for the US. We consider this finding indicative of market participants having a tendency to compensate for upward EM, regardless of the degree of competition of the M&A market in a particular country, given that our sample consists of both high (the UK) and low (rest of sample countries) M&A markets, providing, thus, substantiation for the generalization of such a result.

S.C. Anagnostopoulou, A.E. Tsekrekos / International Review of Financial Analysis 30 (2013) 57–68

Overall, our study builds on the understanding of the mechanics of M&A deals across different institutional environments, by examining across countries with different degrees of competition in their M&A markets a corporate event which has not been examined in the past: the open and public declaration of the intention of a firm to get acquired. We confirm that the degree of competition in a given market may play a role in market performance and earnings management by potential M&A targets or ‘seeking buyer’ firms, well and above actual targets of realized M&A transactions. To conclude, we posit that the deduction of any conclusion on expected firm behavior and market reaction around M&A events cannot be generalized across jurisdictions unless different degrees of competition or institutional differences have been taken into account.

Appendix A In this Appendix, we relegate Table A.1 that reports descriptive statistics for all SB firms collectively and on a country-by-country basis.

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Table A.1 The table reports descriptive statistics of the control variables that are used in the empirical analysis for all companies listed in the London, Paris, Frankfurt and Milan stock exchanges that have publicly announced an intention ‘to be acquired’ between 2000 and 2009 and satisfy the sample selection criteria of Section 4.1. Year t stands for the fiscal year during which the firms publicly announced that an acquirer is sought. Panel A reports descriptive statistics aggregated across all countries/markets, while Panels B provides statistics for each country/market separately. TACFSti stand for total accruals, estimated from the cash flow statement, ΔREVi/TAi stands for the annual change in revenues, divided by lagged total assets, while Ln(TAi) is the natural logarithm of total assets. ROAi is the return on assets, estimated as net income before extraordinary items divided by lagged total assets. Panel A: Descriptive statistics of control variables aggregated across all countries/markets Control variables All countries/markets

Year Mean Median St. Dev. Q1 Q3 Obs. ≥ 0 Obs. b 0

TACFSti

ΔREVi/TAi

ROAi

Ln(TAi)

t −0.0425 −0.0325 0.0696 −0.0665 0.0000 18 47

t −0.0323 0.0007 0.2943 −0.0587 0.0677 34 31

t 1.3196 3.3592 9.2653 0.6125 5.1976 51 14

t 7.6151 7.9014 2.1923 6.2873 9.2328 65 0

Panel B: Descriptive statistics of control variables per stock exchange/country Control variables London stock exchange, UK

Year Mean Median St. Dev. Q1 Q3 Obs. ≥ 0 Obs. b 0

Frankfurt stock exchange, Germany

TACFSti

ΔREVi/TAi

ROAi

Ln(TAi)

TACFSti

ΔREVi/TAi

ROAi

Ln(TAi)

t −0.0433 −0.0346 0.0896 −0.0597 0.0091 8 14

t 0.0376 0.0379 0.1756 0.0014 0.1081 18 4

t 2.7825 4.6299 10.5982 3.1547 7.1815 18 4

t 6.7752 7.1399 2.2742 5.0927 8.6897 22 0

t −0.0392 −0.0353 0.0613 −0.0712 −0.0070 4 11

t −0.1175 −0.0098 0.5317 −0.1219 0.0963 7 9

t −0.4914 2.9964 11.6968 −0.9732 4.4925 12 4

t 7.1577 7.9925 2.0844 5.3524 8.5590 16 0

Control variables Milan stock exchange, Italy

Year Mean Median St. Dev. Q1 Q3 Obs. ≥ 0 Obs. b 0

Paris stock exchange, France

TACFSti

ΔREVi/TAi

ROAi

Ln(TAi)

TACFSti

ΔREVi/TAi

ROAi

Ln(TAi)

t −0.0349 −0.0318 0.0455 −0.0449 −0.0003 5 14

t −0.0820 −0.0386 0.1145 −0.1383 −0.0160 3 16

t 0.2996 3.1064 7.0356 −1.0977 3.5845 13 6

t 8.4198 8.5617 1.8625 7.0768 9.4616 19 0

t −0.0647 −0.0450 0.0781 −0.0697 −0.0239 1 6

t 0.0642 0.0487 0.1031 0.0054 0.0727 6 2

t 3.3408 3.8244 2.3949 1.0563 5.3291 8 0

t 8.9287 9.7619 1.9421 6.7592 10.0636 8 0

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