Does High Leverage Impact Earnings Management? Evidence from Non-Cash Mergers and Acquisitions

Using a sample of US noncash acquirers, we find significant evidence of upward earnings management prior to announcing merger and acquisition deals. In this event study, we adopt an industry adjusted leverage proxy. No evidence of premerger earnings management is found in highly leveraged firms. The results indicate significant evidence of a negative relationship between earnings management and leverage. The evidence remains robust after replacing the leverage proxy with a high/low leverage binary variable, as well as after controlling for the relative size of the deal and profitability of acquirers. No evidence on earnings management by cash acquirers is reported. These findings are consistent with Jensen's Control Hypothesis as well as advocate the view that creditors play crucial roles in monitoring the firm, which would increase the credibility of corporate reports and restrict the use of management's discretionary power to manipulate earnings prior to special business events such as mergers and acquisitions