Does cross‐border acquisition reduce earnings management of emerging market acquirers? Evidence from India

• Published date: 01 March 2022
• Author: Priyesh Valiya Purayil,Jijo Lukose P. J.
• Date: 01 March 2022
• DOI: http://doi.org/10.1111/irfi.12346

ORIGINAL ARTICLE

Does cross-border acquisition reduce earnings

management of emerging market acquirers?

Evidence from India

Priyesh Valiya Purayil

1

| Jijo Lukose P. J.

2

1

Jindal Global Business School, O P Jindal Global University, Sonipat, Haryana, India

2

Indian Institute of Management, Kozhikode, Kerala, India

Correspondence

Priyesh Valiya Purayil, Jindal Global Business

School, O P Jindal Global University, Sonipat,

Haryana 131001, India.

Email: priyeshvpmail@gmail.com,

vppriyesh@jgu.edu.in

Abstract

Cross-border acquisitions by emerging market firms have

been increasing at an accelerated pace. The present study

examines the impact of cross-border acquisition on the

earnings manipulation of emerging market firms by analyz-

ing the cross-border deals from India during the period

2000–2015. Using two proxies for earnings management,

we find that cross-border acquisition reduces the incentive

to manipulate earnings by way of accruals, but not via real

economic transactions. Further, cross-sectional tests reveal

that the incentive to reduce accrual earnings manipulation is

more pronounced when the acquisition is made in countries

with a strong corporate governance structure. Additional

analysis indicates that acquisition results in increased earn-

ings response coefficient for the acquirer firms relative to

the control firms. Our finding is robust even after controlling

for cross-listing and endogeneity associated with cross-

border acquisition decision. The results have implications

for the literature on the spillover of financial reporting prac-

tices across countries due to cross-border business activi-

ties, especially in the context of emerging markets, which

We acknowledge the financial support of National Stock Exchange (NSE)—Indira Gandhi Institute of Development Research (IGIDR) corporate governance

research initiative 2017–18. We also thank an anonymous reviewer, the participants of NSE-IGIDR corporate governance conference-2018 and India

Finance Conference-2019 for their helpful comments.

Received: 16 March 2019 Revised: 29 October 2020 Accepted: 24 January 2021

DOI: 10.1111/irfi.12346

© 2021 International Review of Finance Ltd. 2021

International Review of Finance. 2022;22:143–168. wileyonlinelibrary.com/journal/irfi 143

are known for their weak investor protection and underde-

veloped institutional environment.

KEYWORDS

cross-border mergers and acquisitions, corporate governance,

earnings management, emerging markets

JEL CLASSIFICATION

G3; M41

1|INTRODUCTION

Emerging multinational enterprises (EMNEs) have drastically increased their engagement with international markets

over the last two decades, particularly with the developed markets, by adopting high-risk entry modes like overseas

acquisitions and greenfield investments (Athreye & Kapur, 2009; Bhagat, Malhotra, & Zhu, 2011; Madhok &

Keyhani, 2012). Internationalization through acquisitions helps firms from emerging economies to integrate their

management practices with the advanced organizational capabilities of the host country firms. It enables them to

obtain new technology, markets, and managerial resources (Gubbi, Aulakh, Ray, Sarkar, & Chittoor, 2010). India has

witnessed a marked improvement in internationalization activities in the recent past mainly through outbound

mergers and acquisitions (M&A), akin to other emerging markets. The cumulated stock of India's outward foreign

direct investment (OFDI) reached a staggering figure of $144 billion in 2016- around 7 per cent of its GDP. Specifi-

cally, Indian acquirers made deals worth $8,581 million in 2016, even though the deal value is below the pre-crisis

annual average of $12,335 million (UNCTAD, 2017). Cross-border mergers and acquisitions have received significant

academic attention in the recent past. The impact of acquisitions on firm performance, shareholder value and gover-

nance convergence have been the focus of many studies, particularly in the emerging market context (Aybar &

Ficici, 2009; Chari, Ouimet, & Tesar, 2004; Chi, Sun, & Young, 2011; Col & Sen, 2019; Gubbi et al., 2010;

Purkayastha, Kumar, & Lu, 2017; Singla & George, 2013). Although the relationship between cross-border acquisition

and firm value has been well researched, the mechanism through which cross-border acquisitions benefit the firm

value has not received much empirical attention.

In this study, we examine the financial reporting consequences of overseas acquisitions. Specifically, using the

data on cross-border acquisitions from India, we investigate whether acquirer firms reduce earnings manipulation fol-

lowing their entry into overseas markets through cross-border acquisitions. We build our proposition based on the

bonding hypothesis of Coffee Jr (1999) and the bootstrapping hypothesis of Martynova and Renneboog (2008),

where they predict that internationalization provides a greater incentive to firms for improving their corporate gover-

nance. We employ two popular proxies to detect earnings management, viz. accrual management and real transac-

tions management. Based on prior research, we propose that cross-border acquisitions enable firms from emerging

market countries, known for their underdeveloped institutional environment and governance structure, to improve

their financial reporting quality.

We take the sample of acquirer firms that are listed in the Bombay Stock Exchange (BSE) or National Stock

Exchange (NSE) during the period 2000–2015. By using a regression model, we conclude that cross-border acquisi-

tions result in reduced accrual earnings management. Specifically, we find that firms reduce earnings manipulation

following acquisitions, and the nature of the target country, in terms of corporate governance and regulatory quality,

influences the association between acquisition and earnings manipulation. Additionally, to control for potential endo-

geneity related to cross-border acquisitions, we use the technique of Propensity Score Matching (PSM) to identify

293 pairs of cross-border acquirers and non-acquirer control firms which are similar in firm characteristics. We get

144 VALIYA PURAYIL AND LUKOSE P. J.