DOES PERFORMANCE COMMITMENT IN M&A IMPROVE EARNINGS QUALITY ?

Abstract

I propose an empirical investigation of market response to the implementation of performance commitment in M&As using China's stock market evidence. We hypothesize that performance commitment serves as a tool to reduce information asymmetry of the target in acquisitions and enable investors to better forecast future earnings, thus improving earnings quality. Using a difference-in-difference design(DID), we observe that the investors responsiveness to earnings measured by earnings response coefficient(ERC) for acquirers with performance commitment will exhibit a more significant increase than that of acquirers without performance commitment before and after the completion of M&A. This pattern is more pronounced in firms who exhibit negative unexpected earnings relative to those with positive unexpected earnings. Our evidence suggests that earnings management is more significant in acquirers with positive unexpected earnings due to managers' motives to meet the expected earnings and avoid being punished.