The Effect of Debt Ratio of Acquiring Firms on the Pre-merger Earnings Management in Stock-for-Stock Mergers : Evidence from Korea

The purpose of this study is to investigate whether acquirers with high debt ratios are less motivated to manage earnings before stock-for-stock merger. We find that acquirers with high debt ratios have negative abnormal accruals before stock-for-stock mergers, unlike firms with low debt ratios. This result suggests that there is an effect that the creditor monitors the opportunism of the acquiring firm in stock-for-stock mergers. The negative relationship between the debt ratio of acquiring firms and the pre-merger earnings management was mainly observed in KOSDAQ listed companies where information asymmetry is greater. We also find that the negative relationship between the debt ratio and the pre-merger abnormal accruals is stronger in the service sector (Mainly holding company) than in the manufacturing sector. These results suggest that creditor of the acquiring firm may increase their monitoring activities when acquirers are more likely to manage their earnings prior to stock-for-stock mergers. Overall, the results of this study suggest that creditors have the ability to monitor the opportunistic behavior of acquirers in stock-for-stock mergers.