The Informativeness of Internal Control Weakness Disclosure on Acquirers’ M&A Decisions

Abstract

We examine the relevance of the disclosure of internal control weaknesses (ICWs) by target firms for acquirers in making their merger-and-acquisition (M&A) decisions. Based on a sample of M&A transactions in 2005–2018, we find that acquirers offer lower premiums for targets that disclose ICWs (ICW targets) before the acquisition, compared with targets that disclose no ICWs. This result is contrary to prior studies that rely on accrual quality and other proxies of targets’ information quality. We also find that acquirers offer less cash for ICW targets and that, also contrary to prior studies, ICW disclosure does not increase the probability of renegotiation on deals. The influence of ICW disclosure on premium and payment structure is more pronounced when acquirers and ICW targets are in different industries and when they do not share a common auditor. Overall, the results indicate that ICW disclosure by targets is informative to acquirers. We contribute to the literature by providing a comprehensive analysis on ICW and examining aspects of acquisitions not addressed in previous studies.