Earnings management as predictor of acquisition probability

There are many reasons why firms choose to manage earnings. Planning to acquire another company may be one of them. This paper tests the hypothesis that the probability of making an acquisition is positively related to a firm's level of earnings management, as proxied by current and total discretionary accruals. We also test the hypothesis that the level of discretionary accruals helps to predict the type of target to be acquired. We expect that firms planning to acquire a target in an emerging market would manage earnings more than a firm making an acquisition in a developed market.;Firms financing their acquisitions with shares are also expected to have a high level of earnings management. The results support the hypothesis that the level of earnings management does indeed help predict the likelihood of making an acquisition, and that acquirers manage earnings to a higher degree than do nonacquirers. Acquirers paying with shares have highest discretionary accruals. In contrast to our second hypothesis, we find that acquirers of US firms have the highest discretionary accruals. Finally, firms acquiring targets from emerging economies earn highest abnormal returns around the time the acquisitions are announced.