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Financial Reporting and Conflicting Managerial Incentives: The Case of Management Buyouts

Accounting Department, Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16802
Accounting Department, Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16802
pef5{at}psu.edu
hul4{at}psu.edu

We analyze the effect of external financing concerns on managers' financial reporting behavior prior to management buyouts (MBOs). Prior studies hypothesize that managers intending to undertake an MBO have an incentive to manage earnings downward to reduce the purchase price. We hypothesize that managers also face a conflicting reporting incentive associated with their efforts to obtain external financing for the MBO and to lower their financing cost. Consistent with our hypothesis, we find that managers who rely the most on external funds to finance their MBOs tend to report less negative abnormal accrual prior to the MBOs. In addition, the relation between external financing and abnormal accruals is tempered when there are more fixed assets that can serve as collateral for debt financing.

Key Words: MBO; earnings management; debt financing; managerial incentives
History: Received: June 16, 2007;