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The quality of earnings momentum and performance of mergers & acquisitions

Lei Zhu, 2009
Faculty Advisor: Stephen Penman
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Abstract

This paper provides an accounting explanation for the poor, post-acquisition stock performance of glamour acquirers (high market-to-book ratios). While glamour acquirers show considerable earnings momentum and high market valuations prior to acquisitions, such momentum is not sustainable. Specifically, benchmarked against value acquirers and matching non-acquirers, evidence is consistent with glamour acquirers employing three mechanisms--increasing investments, inflating accruals, and delaying the recognition of core expenses--to temporarily bolster earnings several years prior to acquisitions. In addition, the targets merged with glamour acquirers have higher market-to-book ratios but lower earnings quality than those merged with value acquirers. The poor earnings quality of glamour acquirers then leads to a decline in both operating and stock performance after acquisitions. These results indicate that the underperformance anomaly can be attributed to investors' failure to recognize the poor earnings quality of both glamour acquirers and their targets before acquisitions.

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