The substantial changes in the corporate governance mechanism of acquired firms
that take place during the periods surrounding corporate acquisitions lead investors
and other corporate financiers to an intensive search for financial accounting inputs
for decision making. We examine whether financial accounting information on takeover
targets provides useful input in the corporate governance mechanisms of US publicly
traded takeovers in these periods. Our analysis is by four different types of acquirers:
foreign firms, publicly traded US firms, private US acquirers, and leverage buyouts
(LBOs). We expect that certain firm-specific financial accounting characteristics of takeover
targets by type of potential acquirer affect valuation. To examine this expectation
we construct a probability summary-value measure, composed of eight financial
accounting variables, based on the type of acquirer. We also expect the probability
summary-value measure to be useful for determining investment strategies in acquired
firms. The empirical results strongly support our expectations.
During periods surrounding corporate acquisitions, the corporate governance
mechanism of acquired firms changes substantially. In particular, new
potential financiers such as the new investors and acquiring firms extensively
scrutinize publicly available information in search of inputs. A major research
question that has been partially ignored in prior literature is how relevant
accounting information is during these periods. In these settings, financial
accounting information may play a more prominent role in corporate governance
mechanisms and should therefore have greater value relevance to investors
and other financiers of the firm, increasing their demand for such
information when making decisions.
In this study, we examine the value relevance of information available from
the financial statements of US publicly traded acquired firms prior to the
acquisition. Our focus is on the value relevance of the accounting information
to different types of acquirers and other investors in target firms. We identify
four types of acquirers: foreign firms, publicly traded US firms, private US
acquirers, and leverage buyouts (LBOs). 2 We expect the accounting information
of the acquired firms to differ across types of acquirers and provide different
inputs and signals to investors. In addition, we expect that the accounting
information is useful for investment strategy in choosing among acquired
firms.
Extant accounting studies use earnings and book value of equities to explain
prices and returns. Rather than focusing only on earnings and book values,
which may not provide sufficient information at the end of the firms life cycle,
we construct a probability summary-value measure (Ou and Penman, 1989),
composed of other components of accounting data. This measure includes specific
characteristics of accounting information used by each type of potential
major financier in the corporate governance of takeovers, and differs, on average,
across acquired firms classified by the four types of acquirers.
We use three methodologies to test our research expectations. First, we employ
logistic regressions to generate the probability measure. While constructing
the probability measure, we find that the logistic regression performs well
and certain firm-specific financial accounting characteristics of the acquired
firms are useful in identifying the type of acquirer. 3 Second, we employ
OLS price and return regressions. We find that the probability summary-value
measure is value relevant in price and return models. In particular, we show
that the probability summary-value measure is significant while neither earnings
nor changes in earnings are significant in return models. Third, we use univariate
statistics to examine whether the probability summary-value measure is
useful for investment strategy in choosing among acquired firms. We find that
the probability measure is a very powerful investment instrument. In sum, the
empirical results strongly support our expectations.
The remainder of the paper is organized as follows. The next section provides
further empirical background. The third section details the motivation
and incremental contribution of our study, and provides a literature review.
Section 4 deals with the research methods, and Section 5 presents the data.
Section 6 analyzes the results, and Section 7 provides a summary and
conclusions.
