Corporate control and earnings management: evidence from MBOs

Abstract

Using a matching approach and multivariate logit analysis we determine that management of firms involved in MBOs more frequently chose income increasing accounting policies than did a matched sample of non‐MBO firms. The results provide support for the managerial economic incentives hypothesis as a motivation for accounting policy choices. The results of the study are consistent with a number of earlier studies such as Groff and Wright (1989), Hagerman and Zmijewski (1979) and Zmijewski and Hagerman (1981) that also find support for the managerial economic incentives hypothesis for accounting choices. DeAngelo (1986), Perry and Williams (1994) and Wu (1997) find evidence supporting the hypothesis that, in order to reduce the cost of acquiring shares from current stockholders, managers seeking to take firms private make income decreasing discretionary accruals in the period immediately prior to the MBO. In testing this theory DeAngelo (1986), Perry and Williams (1994) and Wu (1997) focus on the overall effect of a pool of business decisions and accruals made in the year immediately prior to the MBO. We theorize that managements’ self‐serving behavior begins far in advance of the actual MBO. The final terms of the MBO are the culmination of numerous actions and choices by management over a period longer than one year. In testing our hypotheses we focus on three specific accounting policy choices made over a period of three years leading up to an MBO and find significant evidence of self‐serving behavior through the use of income increasing accounting policy choices.