Aloke Ghosh

Financial Leverage Changes Associated with Corporate Mergers

The financial motivation theory on mergers hypothesizes that mergers can create value by increasing debt capacity. Consistent with the increased debt capacity hypothesis, our results show that the average financial leverage (debtdivided by debt plus equity) increases significantly from 32.1% one year before mergers to 38.4% one year after mergers. In a direct test of the hypothesis, cross- sectional regression analysis shows that the change in financial leverage is significantly positively correlated with announcement period abnormal returns. The analysis controls for other tax and operating performance related benefits. We conclude that the stock market incorporates benefits from anticipated financial leverage increases at the time of the merger announcement.

Corporate Boards, Audit Committees, and Earnings Management: Pre- and Post-SOX Evidence

Primarily motivated by the claims that the recent regulatory initiatives empowering boards and audit committees restrain earnings management, we examine whether board characteristics (composition, size, and structure) and audit committee characteristics (composition, size, activity, expertise, ownership, and tenure) are associated with earnings management before and after Sarbanes-Oxley Act (SOX). Using absolute performance-adjusted discretionary accruals, special items, and deferred tax expense as alternative constructs for earnings management, we find that earnings management does not vary with board composition and structure, or with audit committee composition, expertise, and ownership. In contrast, board size and audit committee size, activity, and tenure are associated with earnings management. More important, the strength of this association is considerably weaker for the post-SOX years compared to the pre-SOX years. Finally, we find no evidence to suggest that the overall level of earnings management declined following SOX.

Abnormal Returns and Expected Managerial Performance of Target Firms

We argue that the association between abnormal returns and expected managerial performance of target firms reveals alternative motives behind acquisitions. We test for the disciplinary motive by regressing abnormal returns against the earnings forecast revisions of target firms. A negative slope coefficient is consistent with disciplinary acquisitions because gains from disciplinary actions are likely to be high when target firms’ managerial performance is expected to decline in the future as stand-alone firms. A positive coefficient is consistent with non-disciplinary acquisitions because unexpected increases in targets’ performance as stand-alone firms imply higher expected gains associated with better investment decisions. Our results indicating higher abnormal returns for targets with negative earnings forecast revisions suggest that investors are more optimistic about disciplinary rather than non-disciplinary acquisitions.