The Disciplinary Role of Financial Reporting Quality in Timing Merger Bids with Overvalued Equity

Abstract

How accounting information affects corporate investments is an important question, and prior studies suggest that managers tend to overinvest when their interests do not align with those of shareholders in order to reap perks, build large empires, and entrench their corporate positions. We explore whether high-quality financial reporting helps mitigate the agency conflicts created by overvalued equity in the context of M&A. To address the endogenous nature of the relation between accounting quality and overvalued equity, we identify overvalued equity based on the price pressure caused by relatively exogenous capital flows of mutual funds. We predict and find that high-quality financial reporting attenuates the tendency of managers to bid for acquisitions while the stock of an acquiring firm is overpriced in the equity market. We contribute to the literature by demonstrating a specific mechanism through which high-quality financial reporting moderates value destruction by self-interested managers.