Pre-merger management in developing markets: The role of earnings glamor

Abstract

For a broad, 16-year sample of mergers by Chinese listed firms, we document that income-increasing earnings management through both discretionary accruals and real activities in the year immediately preceding mergers significantly increases the probability of deal payment all or partially in stock. Concomitantly, in contrast to Western developed markets, we find these share-for-share bidders outperform pure-cash bidders during times close to deal announcements; while over longer periods of time, similar to Western markets, underperform pure-cash bidders. Our results are consistent with bidder pre-merger earnings management leading to market expectations reflecting an over extrapolation of bidders' past performance. We interpret our results as acquirer firms in the Chinese developing market being able take advantage of informational voids by signaling. In this case, exploiting a known bias toward “glamor” stocks identified for Western markets by consciously establishing earnings glamor. Results should be of great interest to scholars interested in how known aspects of Western financial systems may or may not be similar in environments of greater institutional voids.