determinants of discretionary accounting choices sample presentation...examples : sanofi-synthelabo...

DETERMINANTS OF DISCRETIONARY ACCOUNTING CHOICES :

EMPIRICAL EVIDENCE FROM FRENCH MERGERS

Jennifer BOUTANT

University of Toulouse

Determinants ?

2

Hypotheses ResultsIntroduction Question ConclusionMethodology

Stock-financed mergersExchange ratio

( transaction price = Nb. of acquiring firm’s shares to

issue for each acquired firm’s share)

Source of conflicts of interest

Examples : Sanofi-Synthelabo – Aventis (2004), Arcelor - Mittal (2006) , Alcatel – Lucent (2006),

GDF – Suez (2008), BHP Billiton – Rio Tinto (2008)

Earnings

management

Wealth

transfers

Exchange

ratio

Acquiring

firm’s value

Objectives

The risks of earnings /

power dilution

The cost of buying the

target

Context :

• in financial press

• in academic researches

Managers

3


Question:

Interests:

Which are the contextual determinants of earnings management

by acquiring firms prior French statutory mergers?

The French institutional context differs from the US/UK context:

Widely-held and family-controlled firms

Weaker mechanisms for minority shareholders protection

The French statutory mergers setting implies heightened incentives:

Irreversible mergers

All shareholders (dominant/minority) vote on the deal

An increased role of accounting figures due to the “multi-criteria approach” requirement

Greater sums involved for each deal

Managers are particularly exposed to

earnings management incentives

4


Theoretical background:

Positive Accounting Theory

M&A context

Specificities of statutory mergers

Corporate Governance

Literature on Earnings Management

French context

Contextual determinants of

earnings management

Hypotheses :

► more direct link between the earnings management and the exchange ratio► Appointment of an additional independent auditor : Big auditors are less tolerant to

earnings management

► A marked change in control and ownership structure so that managers / shareholders

suffer a significant loss of power /wealth

5


Hypotheses:

Relative deal size

Expected dilutive effects

Deal Initiative

Deal nature

Big merger auditor

Use of accounting

criteria

Earnings management

Exchange

ratio

CONTEXTUAL DETERMINANTS

H1 +

H2 +

H3 +

H4 -H5 +

H6 -

ACCOUNTING CHOICES

► Cost/benefit trade-off of earnings management : the larger the relative deal size

=> the higher the economic benefits of earnings management

► Initiators may anticipate the deal contrary to target firms► Negotiations / mutual monitoring more vigorous during takeovers

Earnings localisation to justify the price offered during group reorganisations

107 acquiring firms

6


Sample:

Listed

French Statutory MergersOperations

Paris Stock Exchange / Eurolist

Period 1997 - 2006

Methodology:

Measurement of earnings management (dependent variable)

TAit = αi + ß1i (∆REVit – ∆ARit ) + ß2i PPEit + ß3i CFOit + εit

Discretionary Accruals (DA)

Modified version of Jones

Model (1991)

Estimated by industry using all observations

included in the estimation period

(4 years before the test period “t-1”)

7


Measurement of independent variables

DEALSIZE

DILUTION

INITIATOR

TAKEOVER

M_AUDITOR

AC_CRITERIA

= 1: deal ratio (price of acquired firm’s equity / price of acquiring firm’s equity) >

median deal ratio - 0: otherwise

= 1: % ∆ voting rights of the main acquiring shareholders < 0 - 0: otherwise

= 1: initiator - 0: target

= 1: takeover - 0: group reorganisation

= 1: Big auditor - 0: otherwise

= 1: accounting criteria used >1 - 0: otherwise

Contextual factors

Control variables

MANAGERS

LEVERAGE

FIRMSIZE

BLOC

BOARD

AUDITOR

EARNINGS

% managers’ voting rights

Debt / Equity

ln (total assets)

=1 dominant shareholders (>1/3

voting rights) – 0: otherwise

% of independent directors

=1: Big auditor - 0: otherwise

(earnings – discretionary accruals) / total assets

BLOC

8


Model 1:

DAi = α + β1 DEALSIZEi + β2 DILUTIONi + β3 INITIATORi + β4 TAKEOVERi

+ β5 AC_CRITERIAi + β6 M_AUDITOR + β7MANAGERi + β8 LEVERAGEi

+ β9 FIRMSIZEi + β10 BLOCi + β11 BOARDi + β12 AUDITORi

+ β13 EARNINGSi + εi

Model 2:

DAi = α + β1 DEALSIZEi * DILUTIONi + β2 INITIATORi + β3 TAKEOVERi

+ β4 AC_CRITERIAi + β5 M_AUDITOR + β6MANAGERi + β7 LEVERAGEi

+ β8 FIRMSIZEi + β9 BLOCi + β10 BOARDi + β11 AUDITORi

+ β12 EARNINGSi + εi

Ordinary least squares

Institutional

AC_CRITERIAi = α + β1 INITIATORi + β2 INDUSTRY + β3 FLOAT + εi

Family

Manager

Simultaneous equations

Empirical regression models

9


Choice of valuation criteria

ns : insignificant, * significant at 10% under student and Wilcoxon tests **Control firms = non-acquiring firms comparable in terms of size and industry

Discretionary

accruals

0,043*Means

Acquiring

firms

Dif. of Means 0,050*

-0,007ns

Control

Firms**

0,003ns -0,006ns

T-1 T-2

Acquiring

firms

Control

firms

0,008ns

An upward earnings management just before the deal

Discretionary accounting choices

Combination of instruments

to influence the exchange ratio

► The emphasis placed on

“conservatism” in French accounting

framework

10


Relative deal size

Expected dilutive effects

Deal Initiative

Deal nature

Big merger auditor

Use of accounting

criteria

Earnings management

CONTEXTUAL DETERMINANTS

H1 +

H2 +

H3 +

H4 -

H5 -H6 -

ACCOUNTING CHOICES

CONTROL VARIABLES

Board independence

Leverage

Earnings

-

-

-

Managers

Firmsize

Bloc

Auditor

► Risks that earnings management is

detected and discredits acquiring

managers are too high

Earnings management determinants


Contributions

Extend literature on

Earnings Management in

stock-financed mergers

Managers’ accounting practices in

French statutory mergers

Crucial effects of contextual factors

beyond the contractual &

governance determinants

11

Improve users’ interpretation

of pre-merger financial

disclosures

Implement more appropriate

controls, recommendations

and regulations

Improve users’ capability

to appreciate

the offered price

measures increasing the role of

independent board

Questions on the relevance of

merger auditors’ mission in the

French context


Limits

Simplification resulting from

use of proxies

Further researches

Deepen understanding on the

relationship between

managers’ motivations & manipulation

instruments

Extend this research to other contexts

Choices of criteria / Earnings

management

Other institutional settings /

Other M&A

12

Discretionary accruals / Relative

deal size / dilutive effects

Focus on the

French context

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