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Takeover Threats, Job Security Concerns, and Earnings Management

Exploiting the staggered adoption of country-level takeover laws that increased takeover threats, this paper examines whether the resulting increase in CEOs’ job security concerns leads to greater earnings management. Using a difference-in-difference design, I find that the enactment of laws designed to promote takeover activity is associated with greater earnings management activities (abnormally high accruals, target beating, and poor accruals quality). Furthermore, these activities contribute to increased opacity, as liquidity declines significantly (increased bid-ask spread, percentage of zero-return days, and price impact of trades) following takeover regulation. Impact on earnings management is most pronounced for managers facing the greatest risk of termination at the time of takeover law implementation – those who had been leading firms with poor performance, displaying higher inherent turnover risk, working in a merger intense industry, or working in a country-industry with heavy product market competition. However, strong institutions that can limit CEOs’ ability to manipulate accounting information mitigate the earnings management effects of takeover laws. Overall, my results suggest that reforms aimed at enhancing the monitoring role of governance have unintended consequences because these reforms increase CEOs’ job security concerns and thereby lead to greater earnings management and a more opaque information environment.