Acquirer's earnings quality and the choice of payment method in mergers and acquisitions

Abstract

PurposeThe purpose of this paper is to investigate the role of acquirer's earnings quality on the choice of payment method in mergers and acquisitions (M&A).Design/methodology/approachThe paper applies a simultaneous equations model to address the concern of endogeneity between earnings quality and payment method in corporate acquisitions. In addition, a propensity score matching model is used for robustness purpose.FindingsPrevious studies imply that short‐term accruals have a significant impact on the choice of payment method in M&A. In this study, This paper shows that acquisition financing is not significantly affected by short‐term earnings quality once control variables are considered. Instead, this paper finds that it is the long‐term earnings quality of the acquirer that matters. Acquiring firms with poor (good) long‐term earnings quality prefer lower (higher) cash payment in acquisitions. Their results are robust to different definitions of earnings quality.Research limitations/implicationsResearchers should consider the effect of long‐term earnings quality in their future investigations.Practical implicationsInvestors should be aware of this issue when evaluating corporate mergers.Originality/valueThis is the first study to examine the impact of long‐term quality of earnings on the choice of payment method in M&A.