Review of Accounting Studies

, Volume 18, Issue 4, pp 1050–1087 | Cite as

Target’s earnings quality and bidders’ takeover decisions

  • Kartik Raman
  • Lakshmanan Shivakumar
  • Ane TamayoEmail author


This study examines how takeover decisions are influenced by the quality of information in target firms’ earnings. We show that bidders prefer negotiated takeovers in deals involving targets with poor earnings quality. Moreover, earnings quality and takeover premiums are negatively related in negotiated takeovers, suggesting that bidders obtain valuable private information through negotiations. We also find that bidders share information risk with target shareholders by paying with more equity for targets with poor earnings quality. These findings are driven primarily by the asymmetric information component of earnings quality (as opposed to the symmetric component) and are observed mainly in inter-industry takeovers, where asymmetric information concerns are greater, rather than in intra-industry takeovers. We conclude that targets’ earnings quality affects bidders’ takeover decisions, particularly in cases of large asymmetric information between targets and bidders.


Takeovers Earnings quality Asymmetric uncertainty Negotiation Bid premium Stock payment 

JEL Classification

G34 M41 



We thank Ray Ball, Russell Lundholm (editor), Per Olsson, Sugata Roychowdhury, Henri Servaes, Husayn Shahrur, an anonymous reviewer, and seminar participants at the 2008 London Business School Accounting Symposium, the 2009 Financial Management Association Conference, Erasmus University of Rotterdam, Indian School of Business, Massachusetts Institute of Technology, National University of Singapore, Singapore Management University, Southern Methodist University, University of Auckland, University of Chicago, University of Texas at Dallas, Vanderbilt University, and Washington University for helpful discussions. Shivakumar gratefully acknowledges financial support from the Private Equity Institute, London Business School.


  1. Aboody, D., Hughes, J., & Liu, J. (2005). Earnings quality, insider trading and cost of capital. Journal of Accounting Research, 43(5), 651–673.CrossRefGoogle Scholar
  2. Baker, M., Ruback, R., & Wurgler, J. (2006). Behavioral corporate finance: A survey. In E. Eckbo (Ed.), The handbook of corporate finance: Empirical corporate finance. North Holland: Elsevier.Google Scholar
  3. Bange, M. M., & Mazzeo, M. A. (2004). Board composition, board effectiveness, and the observed form of takeover bids. Review of Financial Studies, 17(4), 1185–1215.CrossRefGoogle Scholar
  4. Barberis, N., & Thaler, R. (2006). A survey of behavioral finance. In G. M. Constantinides, M. Harris, & R. Stulz (Eds.), Handbook of the economics of finance. New York: Elsevier.Google Scholar
  5. Bargeron, L., Schlingemann, F. P., Stulz, R. M., & Zutter, C. J. (2008). Why do private acquirers pay so little compared to public acquirers? Journal of Financial Economics, 89(3), 375–390.CrossRefGoogle Scholar
  6. Bazerman, M. H., & Samuelson, W. (1983). I won the auction but don’t want the prize. Journal of Conflict Resolution, 27(4), 618–634.CrossRefGoogle Scholar
  7. Berkovitch, E., & Khanna, N. (1991). A theory of acquisition markets: Mergers versus tender offers and golden parachutes. Review of Financial Studies, 4(1), 149–174.CrossRefGoogle Scholar
  8. Berkovitch, E., & Narayanan, M. P. (1990). Competition and the medium of exchange in takeovers. Review of Financial Studies, 3(2), 153–174.CrossRefGoogle Scholar
  9. Bharath, S., Sunder, J., & Sunder, S. V. (2008). Accounting quality and debt contracting. The Accounting Review, 83(1), 1–28.CrossRefGoogle Scholar
  10. Bhattacharya, N., Desai, H., & Venkataraman, K. (2007). Earnings quality and information asymmetry: Evidence from trading costs. Working paper, Southern Methodist University.Google Scholar
  11. Boone, A., & Mulherin, J. H. (2007). How are firms sold? Journal of Finance, 62(2), 847–875.CrossRefGoogle Scholar
  12. Boone, A., & Mulherin, J. H. (2008). Do auctions induce a winner’s curse? Evidence from the corporate takeover market. Journal of Financial Economics, 89(1), 1–19.CrossRefGoogle Scholar
  13. Brown, S., & Hillegeist, S. (2007). How disclosure quality affects the level of information asymmetry. Review of Accounting Studies, 12(2/3), 443–477.CrossRefGoogle Scholar
  14. Bushman, R. M., Chen, Q., Engle, E., & Smith, A. (2004). Financial accounting information, organizational complexity and corporate governance systems. Journal of Accounting and Economics, 37(2), 167–201.CrossRefGoogle Scholar
  15. Bushman, R. M., & Smith, A. (2001). Financial accounting information and corporate governance. Journal of Accounting and Economics, 32(1–3), 237–333.CrossRefGoogle Scholar
  16. Chaney, P., Jeter, D., & Lewis, C. (1998). The use of accruals in income smoothing: A permanent earnings hypothesis. In C. F. Lee (Ed.), Advances in quantitative analysis of finance and accounting (Vol. 6, pp. 103–135). Singapore: World Scientific.Google Scholar
  17. Conn, R. L., Cosh, A., Guest, P. M., & Hughes, A. (2005). The impact on UK acquirers of domestic, cross-border, public and private acquisitions. Journal of Business Finance and Accounting, 32(5–6), 815–870.CrossRefGoogle Scholar
  18. Cornett, M. M., Marcus, A., & Tehranian, H. (2008). Earnings management, corporate governance, and financial performance. Journal of Financial Economics, 87(2), 357–373.CrossRefGoogle Scholar
  19. Cotter, J. F., & Zenner, M. (1994). How managerial wealth affects the tender offer process. Journal of Financial Economics, 35(1), 63–97.CrossRefGoogle Scholar
  20. Damodaran, A. (2006). The value of transparency and cost of complexity. Working paper, New York University.Google Scholar
  21. Dechow, P., & Dichev, I. (2002). The quality of accruals and earnings: The role of accrual estimation errors. The Accounting Review, 77(Supplement), 35–59.CrossRefGoogle Scholar
  22. Defond, M. L., & Park, C. W. (2001). The reversal of abnormal accruals and the market valuation of earnings surprises. The Accounting Review, 76(3), 375–404.CrossRefGoogle Scholar
  23. Diamond, D. (1985). Optimal releases of information by firms. Journal of Finance, 40(4), 1071–1094.CrossRefGoogle Scholar
  24. Dong, M., Hirshleifer, D., Richardson, S., & Teoh, S. (2006). Does investor misvaluation drive the takeover market? Journal of Finance, 61(2), 725–762.CrossRefGoogle Scholar
  25. Doyle, J., Ge, W., & Mcvay, S. (2007). Accruals quality and internal control over financial reporting. The Accounting Review, 82(5), 1141–1170.CrossRefGoogle Scholar
  26. Easley, D. S., Hvidkjaer, S., & O’Hara, M. (2002). Is information risk a determinant of asset returns? Journal of Finance, 57(5), 2185–2221.CrossRefGoogle Scholar
  27. Easley, D. S., & O’Hara, M. (2004). Information and the cost of capital. Journal of Finance, 59(4), 1553–1583.CrossRefGoogle Scholar
  28. Eckbo, B. E., Giammarino, R. M., & Heinkel, R. L. (1990). Asymmetric information and the medium of exchange in takeovers: Theory and tests. Review of Financial Studies, 3(4), 651–675.CrossRefGoogle Scholar
  29. Epstein, L., & Schneider, M. (2008). Ambiguity, information quality and asset prices. Journal of Finance, 63(1), 197–228.CrossRefGoogle Scholar
  30. Eso, P., & Szentes, B. (2007). Optimal information disclosure in auctions and the handicap auction. Review of Economic Studies, 74(3), 705–731.CrossRefGoogle Scholar
  31. Fama, E., & French, K. (1997). Industry costs of equity. Journal of Financial Economics, 43(2), 153–193.CrossRefGoogle Scholar
  32. Fishman, M. J. (1989). Preemptive bidding and the role of medium of exchange in acquisitions. The Journal of Finance, 44(1), 41–57.CrossRefGoogle Scholar
  33. Francis, J. R., LaFond, R., Olsson, P., & Schipper, K. (2004). Costs of equity and earnings attributes. The Accounting Review, 79(4), 967–1010.CrossRefGoogle Scholar
  34. Francis, J. R., LaFond, R., Olsson, P., & Schipper, K. (2005). The market pricing of earnings quality. Journal of Accounting and Economics, 39(2), 295–327.CrossRefGoogle Scholar
  35. Francis, J. R., Nanda, D. J., & Olsson, P. (2008). Voluntary disclosure, earnings quality and cost of capital. Journal of Accounting Research, 46(1), 53–99.CrossRefGoogle Scholar
  36. Glosten, L. R., & Milgrom, P. (1985). Bid, ask and transaction prices in a specialist market with heterogeneously informed traders. Journal of Financial Economics, 14(1), 71–100.CrossRefGoogle Scholar
  37. Gompers, P., Ishii, J. L., & Metrick, A. (2003). Corporate governance and equity prices. Quarterly Journal of Economics, 118(1), 107–155.CrossRefGoogle Scholar
  38. Hansen, R. G. (1987). A theory of the choice of exchange medium in the market for corporate control. Journal of Business, 60, 75–95.CrossRefGoogle Scholar
  39. Holmes, T. J., & Schmitz, J. A., Jr. (1995). On the turnover of business firms and business managers. Journal of Political Economy, 103(5), 1005–1038.CrossRefGoogle Scholar
  40. Holmstrom, B., & Kaplan, S. N. (2001). Corporate governance and merger activity in the United States: Making sense of the 1980s and 1990s. Journal of Economic Perspectives, 15(2), 121–144.CrossRefGoogle Scholar
  41. Hutton, A. P., Marcus, A. J., & Tehranian, H. (2009). Opaque financial reports, R2, and crash risk. Journal of Financial Economics, 94(1), 67–86.CrossRefGoogle Scholar
  42. Jenkins, P., Politi, J., & Wiesmann, G. (2006). BASF launches hostile bid for Engelhard. Financial Times Intelligence, January 4, 1.Google Scholar
  43. Klein, A. (2002). Audit committee, board of director characteristics, and earnings management. Journal of Accounting and Economics, 33(3), 375–400.CrossRefGoogle Scholar
  44. Koller, T., Goedhart, M., & Wessels, D. (2005). Valuation: Measuring and managing the value of companies (4th ed.). Hoboken, NJ: Wiley.Google Scholar
  45. Lambert, R., Leuz, C., & Verrechia, R. (2007). Information asymmetry, information precision and the cost of capital. Working paper, University of Pennsylvania and University of Chicago.Google Scholar
  46. Lang, M. H., & Lundholm, R. J. (1996). Corporate disclosure policy and analyst behavior. The Accounting Review, 71(4), 467–492.Google Scholar
  47. Lee, G., & Masulis, R. W. (2009). Seasoned equity offerings: Quality of accounting information and expected flotation costs. Journal of Financial Economics, 92(3), 443–469.CrossRefGoogle Scholar
  48. Marquardt, C. A., & Zur, E. (2010). The role of accounting quality in the M&A market. Working paper, Baruch College.Google Scholar
  49. Martin, K. (1996). The method of payment in corporate acquisitions, investment opportunities, and management ownership. Journal of Finance, 51(4), 1227–1246.CrossRefGoogle Scholar
  50. McNichols, M. (2002). Discussion of “The quality of accruals and earnings: The role of accrual estimation errors”. The Accounting Review, 77, 61–69.CrossRefGoogle Scholar
  51. McNichols, M., & Stubben, S. (2012). The effect of target-firm accounting quality on valuation in acquisitions. Working paper, Stanford University.Google Scholar
  52. Meulbroek, L. (1992). An empirical analysis of illegal insider trading. Journal of Finance, 47(5), 1661–1699.CrossRefGoogle Scholar
  53. Milgrom, P., & Weber, R. J. (1982). The value of information in a sealed-bid auction. Journal of Mathematical Economics, 10(1), 105–114.CrossRefGoogle Scholar
  54. Moeller, S. B., Schlingemann, F., & Stulz, R. M. (2007). How do diversity of opinion and information asymmetry affect acquirer returns? Review of Financial Studies, 20(6), 2047–2078.CrossRefGoogle Scholar
  55. Officer, M. S. (2003). Termination fees in mergers and acquisitions. Journal of Financial Economics, 69(3), 431–467.CrossRefGoogle Scholar
  56. Officer, M. S., Poulsen, A. B., & Stegemoller, M. (2009). Target-firm information asymmetry and acquirer returns. Review of Finance, 13(3), 467–493.CrossRefGoogle Scholar
  57. Pastor, L., & Veronesi, P. (2003). Stock valuation and learning about profitability. Journal of Finance, 58(5), 1749–1789.CrossRefGoogle Scholar
  58. Pastor, L., & Veronesi, P. (2006). Was there a Nasdaq bubble in the late 1990s? Journal of Financial Economics, 81(1), 61–100.CrossRefGoogle Scholar
  59. Prabhala, N. R. (1997). Conditional methods in event studies and an equilibrium justification for using standard event-study proceduresd. Review of Financial Studies, 10(1), 1–38.CrossRefGoogle Scholar
  60. Rogers, W. (1993). Regression standard errors in clustered samples. Stata Technical Bulletin, 13, 19–23.Google Scholar
  61. Rogo, R. (2009). The effect of valuation uncertainty in the choice of selling mechanism. Working paper, University of British Columbia.Google Scholar
  62. Roll, R. (1986). The hubris hypothesis of corporate takeovers. Journal of Business, 59(2), 197–216.CrossRefGoogle Scholar
  63. Schwert, G. W. (1996). Markup pricing in mergers and acquisitions. Journal of Financial Economics, 41(2), 153–192.CrossRefGoogle Scholar
  64. Schwert, G. W. (2000). Hostility in takeovers: In the eyes of the beholder? Journal of Finance, 55(6), 2599–2640.CrossRefGoogle Scholar
  65. Shivakumar, L. (2000). Do firms mislead investors by overstating earnings around seasoned equity offerings? Journal of Accounting and Economics, 29(3), 339–371.CrossRefGoogle Scholar
  66. Subramanyam, K. R. (1996). The pricing of discretionary accruals. Journal of Accounting and Economics, 22(1–3), 249–281.CrossRefGoogle Scholar
  67. Thaler, R. (1988). Anomalies: The winner’s curse. Journal of Economics Perspectives, 2(1), 191–202.CrossRefGoogle Scholar
  68. Urcan, O., Radhakrishnan, S., & Demirkan, S. (2008). Earnings quality and excess value of diversification. Working paper, London Business School.Google Scholar
  69. Varaiya, N. (1988). The winner’s curse hypothesis and corporate takeovers. Managerial and Decision Economics, 9(3), 209–219.CrossRefGoogle Scholar
  70. Venkatesh, P. C., & Chiang, R. (1986). Asymmetry and the dealer’s bid-ask spread: A case study of earnings and dividend announcements. Journal of Finance, 41(5), 1089–1102.CrossRefGoogle Scholar
  71. Warfield, T. D., Wild, J. J., & Wild, K. L. (1995). Managerial ownership, accounting choices, and informativeness of earnings. Journal of Accounting and Economics, 20(1), 61–91.CrossRefGoogle Scholar
  72. Watts, R. L., & Khan, M. (2009). Estimation and empirical properties of a firm-year measure of conservatism. Journal of Accounting and Economics, 48(2–3), 132–150.Google Scholar
  73. White, H. (1980). A heteroscedasticity-consistent covariance matrix estimator and a direct test for heteroscedasticity. Econometrica, 48, 817–838.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media New York 2013

Authors and Affiliations

  • Kartik Raman
    • 1
  • Lakshmanan Shivakumar
    • 2
  • Ane Tamayo
    • 3
    Email author
  1. 1.Bentley UniversityWalthamUSA
  2. 2.London Business SchoolLondonUK
  3. 3.London School of EconomicsLondonUK

Personalised recommendations