Takeover Threats, Job Security Concerns, and Earnings Management

Abstract

ABSTRACT Using the staggered adoption of takeover laws, this study examines implications of takeover threats on earnings management around the world. I find that the enactment of takeover legislation leads to increased earnings management (abnormally high accruals, target beating, and poor accruals quality). Results are driven by underperforming managers with higher turnover risk in countries with high increases in turnover sensitivity to performance, indicating job security concerns as the channel through which takeover laws increase earnings management. Furthermore, results are strongest in countries with weak investor protection, where existing governance mechanisms are weaker and earnings management is more prevalent. Moreover, regulation provisions that most directly increase takeover threats experience greater earnings management responses. Additionally, I show that accounting restatements and fraud scandals become more frequent following takeover legislation. Overall, I provide evidence that takeover reforms, although enhancing discipline of underperforming managers, inadvertently incentivize accounting manipulation due to heightened job security concerns. JEL Classifications: G34; G38; K22; M41; M43.