By
Charles A. Barragato
Long Island University – C.W. Post Campus
720 Northern Boulevard
Brookville, NY 11548-1300
Tel: (516) 299-3279
Fax: (516) 299-2297
Charles.Barragato@liu.edu
Ariel Markelevich
Long Island University – C.W. Post Campus
720 Northern Boulevard
Brookville, NY 11548-1300
Tel: (516) 299-2085
Fax: (516) 299-2297
Ariel.Markelevich@liu.edu
December 31, 2003

Earnings Quality Following Corporate Acquisitions
Abstract
We use the corporate acquisition setting to examine earnings quality during the postacquisition period. We define earnings quality as an earnings stream more closely associated with future cash flows from operations. We use the stock market’s reaction at the acquisition announcement to infer merger motives and hypothesize that synergy-motivated acquisitions will produce higher quality earnings than agency-motivated acquisitions. Our findings are consistent with this prediction and support the view that managers who pursue synergy or agency-motivated acquisitions do not face the same economic environment and incentive schemes. Our results are also consistent with the notion that incentives for earnings management are greater following agency-motivated acquisitions when compared to those of synergy-motivated acquisitions. We conjecture that these differences originate from those accounting-based contracts that are likely impacted by reported post-acquisition balance sheet and income statement amounts.
Keywords: Agency, cash flow prediction, mergers, synergy
Data Availability: Data are available from the sources identified in the paper
1

1. Introduction
Earnings quality is of interest to users of financial statements because earnings, and the varied metrics derived there from, are utilized in making contracting and investment decisions. From a contracting perspective, low-quality earnings may result in unintended wealth transfers. From an investor’s vantage point, low-quality earnings are undesirable because they result in a defective resource allocation signal (Schipper and Vincent, 2003). In this paper, we study the quality of earnings following corporate acquisitions. Corporate acquisitions represent an important economic activity, with total yearly activity reaching about 5% of total stock market value.
1 Specifically, we examine the relationship between the motive for an acquisition and the quality of post-acquisition long-term earnings.
Prior literature has identified synergy and agency as two principal motives for corporate takeovers. We identify, ex-ante, synergistic and agency-motivated takeovers. We hypothesize and find that takeovers motivated by synergy (agency) produce earnings of a higher (lower) quality. Our results are consistent with the belief that agency-motivated takeovers typically suffer from inefficiencies and the misallocation of capital. They also support the view that managers who pursue synergy- or agency-motivated acquisitions do not face the same economic environment and incentive schemes. Our evidence is also consistent with the notion that incentives for earnings management are higher following agencymotivated acquisitions when compared to those of synergy-motivated acquisitions.
We define high quality earnings as an earnings stream more closely associated with future operating cash flows, a definition that appears in numerous financial analysts’ reports and treatises on financial statement analysis (Schipper and Vincent, 2003). Our metric is also
1 For example, 8,423 merger deals were announced in 2001. These mergers were valued at $704 billion and represented 5% of the total market value of firms traded on the NYSE, NASDAQ, and AMEX during that year
(based on information from Mergerstat.com for US and US cross-border mergers).
2

consistent with prior research documenting the superiority of earnings in predicting future operating cash flows and is related to a stream of research that describes accrual quality as the extent to which accruals map into cash flow realizations (Dechow and Dichev, 2002,
Sloan, 1996 and Dechow, 1994).
2
Our study contributes to the literature on earnings quality and corporate acquisitions on several dimensions. First, we analyze the economic benefits (detriments) derived from those accounting-based contracts that will likely be impacted by an acquisition transaction and link them to motives for takeovers documented in existing finance literature. Second, we operationalize an earnings quality construct grounded in the notion that “closeness-to-cash” signals higher earnings quality. Use of this construct has been embraced by the financial community and is consistently employed by financial analysts as a check on the quality of income. Third, we offer a methodology that can aid in predicting, ex ante, whether takeover transactions will likely produce an earnings stream of higher or lower quality. Our methodology can also be used to help sort out and validate, from an accounting perspective, whether a merger was successful (Penman, 2003).
3
The remainder of the paper is organized as follows. Section 2 describes the prior literature and develops the empirical predictions. Section 3 presents the research design.
Section 4 describes the sample and provides descriptive statistics. Section 5 reports the findings, while Section 6 concludes.
2 Our definition is also consistent with the view that financial reporting should provide information that is useful in assessing the amounts, timing and uncertainties of prospective cash inflows (SFAC No. 1, FASB, 1978)
3 Penman (2003) states that “sorting out, from the accounting, whether a merger was a successful one is not an easy task. It is hard to find an anchor, nor is the appropriate accounting remedy clear”. We argue that using a closeness-to-cash metric to evaluate a merger (from the accounting) in the post-acquisition period is one such anchor.
3

2. Prior Literature and Empirical Predictions
2.1 Motives for corporate acquisitions
Because corporate acquisitions are undertaken for different reasons, they cannot be evaluated as a homogenous group. For example, some corporate acquisitions are pursued to benefit the acquiring shareholders, while others are pursued to benefit the acquiring managers at the expense of the acquiring firm’s shareholders.
4
Synergistic acquisitions are defined as acquisitions where the value of the combined firm is larger than the sum of its parts. Theory suggests that takeovers motivated by synergy will be in the best interest of acquiring firms’ shareholders and result in an increase in postacquisition long-term performance. In agency-motivated acquisitions, managers acquire firms for their own personal benefit, at the expense of their firm’s shareholders, and are expected to result in a decrease in post-acquisition long-term performance.
The stock market reacts to the announcement of the acquisition and forms an expectation concerning the impact of the acquisition on the value of the companies involved in the acquisition. Thus, when a synergy-motivated acquisition is announced, one expects a positive reaction by the stock market. Alternatively, when an agency-motivated acquisition is announced, the stock market should react negatively.
We therefore use the stock market’s reaction at the date of announcement to categorize acquisitions into two groups, i.e.; those motivated by either synergy or agency.
5
4 Further evidence that managers do not always act in the best interest of shareholders can be found in Bebchuk et al. (2001), who look at executive compensation in the United States. The authors contrast the optimal contracting view vs. the rent extraction view in manager's compensation. After examining a large body of empirical evidence, they find evidence consistent with the rent extraction view.
5 For a detailed overview of motives for acquisitions, see Markelevich (2003), Weston et al. (2001) pp. 138-153, and Berkovitch and Narayanan (1993).
4

2.2 Accounting-based contracts and motives for takeovers
A principal question we examine in this paper is whether it is possible to predict if a takeover motivated by synergy (agency) will produce a future earnings stream of higher
(lower) quality. To examine the potential conditions that will affect the motives for acquisitions, we begin by identifying the economic benefits (detriments) derived from those accounting-based contracts that will likely be impacted in a takeover transaction. We then use the motive for the acquisition to predict the likelihood of reporting earnings of a higher or lower quality.
A number of studies have documented a relationship between accounting decisions and performance-based compensation plans (see Healy and Wahlen, 1999, for a review).
Managers have incentives to enter into takeovers if their current and long-term performancebased compensation is enhanced. Managers also have incentives to undertake “big baths” because of the presence of “floors” in their bonus plans (Healy, 1985). Similarly, studies have also demonstrated that managers use accounting discretion to improve their job security, even where such behavior involves the inefficient allocation of corporate resources
(DeAngelo, 1988; Dechow and Sloan, 1991). We expect the economic goals of acquirer managers in a synergistic takeover to be aligned with those of their shareholders.
Alternatively, we expect acquirer managers in an agency-motivated takeover to be primarily motivated by short-term goals and an incentive to extract wealth from the acquirer’s shareholders.
6
6 We implicitly assume that managers who act opportunistically do not incur costs (damage to reputation, etc.) sufficient to deter their actions to initiate takeovers. This discussion is also consistent with Amihud and Lev
(1981), who posit that agency-motivated takeovers are initiated to help diversify management’s personal portfolio and Shleifer and Vishny (1989), who suggest that some takeovers are consummated to acquire assets and increase the acquirer’s dependence on management.
5

Prior literature also documents that violating covenants can be costly (Beneish and
Press, 1993). We conjecture that managers of acquiring firms with binding debt constraints are more inclined to choose among accounting alternatives that will avoid their technical violation rather than those that are in the best interest of the acquirer’s shareholders (DeFond and Jiambalvo, 1994; Sweeney, 1994).
Markelevich (2003) shows that synergy-motivated acquisitions result in higher postacquisition long-term performance than agency-motivated acquisitions. Additionally, synergy-motivated transactions result, on average, in stronger post-acquisition balance sheets, particularly those that were accounted for under the purchase method prior to the effective date of Statement of Financial Accounting Standards No. 141 (FASB, 2001). A stronger balance sheet will likely improve a variety of performance ratios, particular those related to leverage.
7
Based on the foregoing, we conjecture that managers who pursue synergy or agencymotivated acquisitions do not face the same economic environment both before and after the acquisition. We thus hypothesize that companies who pursued synergy-motivated acquisitions will, on average, report earnings of a higher quality than those companies who pursued agency-motivated acquisitions.
3.
Research Design
3.1 Identifying acquisition motives
Following Markelevich (2003) and Berkovitch and Narayanan (1993), we use the exante stock market reaction at the acquisition announcement to identify acquisition motives.
7 Aboody, Kasznik and Williams (2000) argue that while use of the purchase method has adverse income effects, it typically results in a more favorable post-merger balance sheet than pooling (e.g.; higher book value of equity).
6

We assess the market’s reaction by examining the cumulative abnormal returns (CAR) accruing to the acquirer and target firms around the announcement. The acquirer (target)
CAR is interpreted to represent the stock market’s estimate of whether an acquisition is in the interest of the acquirer (target) shareholders. The total CAR (the sum of the acquirer CAR and the target CAR) is construed as the stock market’s estimate of whether wealth is created or destroyed as a result of the acquisition.
We utilize the following criteria, as summarized in Table 1, to classify the type of acquisition based on both the acquirer’s CAR and the total CAR. An acquisition in which both the acquirer CAR and the total CAR are positive implies a synergistic motive, since the acquisition is in the interest of the acquiring shareholders and creates value. Acquisitions in which the acquirer’s CAR and total CAR are negative are classified as agency-motivated transactions, since the stock market’s reaction to the acquisition announcement suggests a diminution in value and is not in the interest of the acquiring firm’s shareholders. A transaction that generates negative CAR to the acquirer and total positive CAR also suggests that the acquisition is not in the interest of the acquiring shareholders, despite the fact that this type of acquisition creates value (a case of synergy). This market reaction is consistent with the hubris hypothesis, whereby managers of the acquiring firm are viewed to have overpaid for the acquisition (Roll, 1986). In the case of hubris, the target captures all gains resulting from future synergies, and some additional wealth transferred from the acquirer.
Lastly, in transactions where the acquirer accrues positive CAR but the total CAR is negative, we offer no theoretical explanation consistent with this scenario. We label these acquisitions as undefined.
7

In sum, taking into account both the frequency of takeovers classified into each group and theoretical considerations, we focus our analysis on acquisitions identified as motivated by either synergy or agency.
3.2
Measuring earnings quality
Several alternative earnings quality measures have been advanced in the literature
(see Schipper and Vincent, 2003, for a review). These methods employ a variety of empirical models to estimate accruals using historical data, which becomes problematic and difficult to operationalize in an acquisition transaction since the fundamentals of a firm change post-acquisition. Additionally, firms that have participated in a merger, acquisition or divestiture are likely to experience nonarticulation problems between balance sheet and income statement items, which can further confound results (Collins and Hribar, 2002).
Therefore, we opt to focus our analysis on a prospective closeness-to-cash earnings quality construct. We measure earnings quality by examining the relation between firms’ operating earnings and operating cash flows. We define high quality earnings as an earnings stream more closely associated with future cash flows from operations. Our definition is consistent with the view that financial reporting should provide information that is useful in assessing the amounts, timing and uncertainties of prospective cash inflows (SFAC No. 1,
FASB, 1978). It is also consistent with prior research documenting the predictive abilities of earnings for future cash flows (Barth, Cram and Nelson, 2001; Dechow, Kothari and Watts,
1998 and Finger, 1994) and is related to a developing stream of research that describes accrual quality as the extent to which accruals map into cash flow realizations (Dechow and
Dichev, 2002; Sloan, 1996 and Dechow, 1994).
8

Use of a closeness-to-cash benchmark measure has also been advocated in many textbooks on financial statement analysis, principally because cash is assumed to be objective and not manipulable (Schipper and Vincent, 2003). Bernstein (1993) suggests that analysts prefer to relate cash flow from operations to reported net income as a check on the quality of that income. Similarly, Penman (2001) states that the focus of an accounting quality analysis is on distinguishing “hard” numbers, which result from cash flows, from “soft” numbers in the accruals, which are subject to estimate. Hence, we argue that an earnings stream that is a better predictor of future operating cash flows is of higher quality.
Barth, Cram and Nelson (2001) find that disaggregating cash flow from aggregate accruals significantly increases predictive ability relative to earnings. In the spirit of Barth et al., we estimate the following empirical model to assess the ability of operating earnings to predict one-period ahead operating cash flows: 8
CFO t+1
= +
1
CFO t
+
2
ACC t
+ t+1
Following Dechow and Dichev (2002), we define cash flow from operations (CFO) as item
308 in Compustat . Total accruals (ACC) are calculated as the difference between EARN
(operating income after depreciation, item 178 in Compustat ) and CFO. All variables used in the study are deflated by average total assets (an average of item 6 in Compustat ). We also calculate cash flows from operations as defined in Healy, Palepu and Ruback (1992): sales
(item 12 in Compustat ) minus the cost of goods sold (item 41) minus selling and administrative costs (item 189) plus depreciation and amortization (item 14). Using this
8 Barth, Cram and Nelson (2001) go on to conclude that disaggregating accruals into major components further increases predictive ability. With respect to our sample, there are a number of accrual component changes that are unavailable directly from the statement of cash flows. Alternatively, we could compute these missing components indirectly using balance sheet amounts. However, using balance changes to derive accruals may confound results, particularly for those entities that have participated in a merger or acquisition (Collins and
Hribar, 2002). We therefore chose to limit our disaggregation to total accruals, which in our view is more conservative, parsimonious and mitigates potential measurement error issues.
9

measure produced similar results. Likewise, we use an alternative measure for earnings, income before extraordinary items (item 18 in Compustat ), which also produced qualitatively similar results.
We assess earnings quality for each group by examining the significance of the
1
and
2 coefficients, as well as the magnitude of the adjusted R 2 in the post-acquisition period. The model is estimated annually for the first three years following the acquisition. We compute annual regressions (as opposed to pooling observations) to capture potential differences in earnings quality for periods nearer to or farther from the acquisition. Following Harris, Lang and Moller (1994) and Cramer (1987), we compare regression R 2 s by calculating a Z-statistic based on the expectation and variance of R 2 for large samples.
4.
Sample Selection and Descriptive Statistics
4.1
Sample selection
Our analysis is based on a sample of all completed mergers of US public companies between 1987 and 1999. We use only completed mergers because our tests examine the quality of post-acquisition long-term earnings. All financial statement data were obtained from COMPUSTAT . Stock price data were retrieved from the Center for Research in Security
Prices ( CRSP ) database.
Table 2 describes the sample selection process: 3,950 mergers were identified using the Securities Data Company ( SDC ) database. After excluding all mergers involving firms in the financial sector (SIC code 6XXX), 2,554 mergers remained. We deleted firms that were not found in the COMPUSTAT or CRSP databases, or did not have sufficient data, decreasing our sample to 1,124 mergers. We then chose only mergers classified as either synergy or
10

agency-motivated (as described in Table 1). This selection further reduced our sample to 921 mergers. Lastly, we truncated the extreme 1% of CFO or EARN, which yielded a final sample of 907 mergers.
4.2
Descriptive statistics - c lassification of motives for mergers
We use the event window of five days before the announcement to five days after the announcement as our proxy for the market’s reaction to the acquisition announcement.
9 We classify acquisitions based on the inferred motive. The results of this classification are presented in Panel A of Table 3. We classify 457 mergers (41% of the sample) as motivated by synergy, 152 mergers as cases of hubris (14% of the sample), 464 mergers (41% of the sample) as motivated by agency, and only 51 mergers (4% of the sample) as undefined.
4.3 Characteristics of the merged firm
Descriptive statistics concerning firm characteristics are described in Panel B of
Table 3. We present means and medians for total assets (item 6 in Compustat ), EARN
(operating income after depreciation - item 178 in Compustat ) and CFO (cash flow from operations - item 308 in Compustat ). Mean values for each variable exceed their median values, suggesting distributions that are right-skewed. More importantly, the mean and median values for the synergy and agency groups do not display patterns that are materially different from one another.
Panel C of Table 3 presents pooled means and medians for the variables CFO, EARN and ACC, each scaled by average total assets. CFO and EARN display patterns similar to those of their unscaled counterparts in Panel B. Consistent with prior literature, mean ACC is negative for the overall sample, as well as for the synergy and agency groups.
9 The choice of event window is consistent with Berkovitch and Narayanan (1993) and Markelevich (2003).
The use of different event windows in the study produced similar results.
11

5.
Results
As described in Section 4, we regress next period’s CFO on current CFO and ACC for each of the three years following the corporate acquisition. We assess earnings quality by examining the synergy and agency group’s adjusted R 2 s, as well as the significance of their respective regression coefficients.
10
Table 4 presents our regression results. Synergy-motivated acquisitions generate consistently higher adjusted R 2 s in each of the three years following the acquisition when compared against the agency group (0.465, 0.413, and 0.579 versus 0.412, 0.318, and 0.422, respectively). To assess the significance of the difference between R 2 ’s for the synergy and agency regressions, we compute a Z-statistic following Harris et al. (1994) and Cramer
(1987).
11 We find the Z-statistic to be marginally significant in the first post-acquisition year
(Z=1.21) and highly significant in the second and third years following the acquisition
(Z=2.10 and Z=3.34, respectively). All coefficient values are significant in all years for both groups. These associations are consistent with our hypothesis and support the notion that the quality of earnings following synergy-motivated acquisitions is higher than the quality of earnings following agency-motivated acquisitions.
With respect to the synergy group, the association between next period’s CFO and current CFO and ACC is lower for the first and second years following the corporate acquisition, but increases sharply in the third year. We conjecture that this lower association
10 Extending our tests an additional year substantially reduces the number of observations in the post-acquisition period. Additionally, as we move further away in time from the acquisition date, our results may be affected by other events. We therefore limit our post-acquisition analysis to three years.
11 The Z-statistic is computed as
2 (
R 2
Synergy
R 2
Synergy
)
R
2
Agency
2 ( R 2
Agency
)
12

is the result of one-time accounting adjustments related to the integration and re-alignment of resources in the newly merged entity. These adjustments, the majority of which take place in the first post-acquisition period, typically result from the implementation of initiatives related to the integration of operations and the consolidation of administrative and support functions.
Similar adjustments may also result from a re-assessment of carrying values due a change in the composition and/or utilization of the acquirer and target’s combined assets and liabilities.
After these non-recurring adjustments are recognized, the newly-merged entity reaches a new operating equilibrium and begins to realize anticipated synergies and a more persistent stream of operating performance in the ensuing years.
As for the agency group, we find earnings generally to be of lower quality. This lower association is consistent in each of the three post-acquisition periods, suggesting that agency-motivated acquisitions are less efficient and likely result in the misallocation of capital. These findings are also consistent with the earnings manipulation results in Nelson,
Elliott and Tarpley (2002), who posit that managers will attempt to manage earnings as they relate to debt covenants, executive compensation and market expectations, even where the earnings manipulation has no clear current year income effect, e.g.; accruing large reserves and offsetting them with goodwill in a purchase acquisition.
5.1
Additional tests
5.1.1 Alternative classification methods
Markelevich (2003) proposes an alternative method to classify acquisition motives.
His method entails developing a joint function of (1) initial market reaction information and
(2) accounting information available at the time of the merger announcement. Our results
13

(untabulated) remain qualitatively unchanged when we use the Markelevich scoring system to classify acquisition motives.
5.1.2 Accounting for business combinations
Prior to the issuance of SFAS No. 141, Accounting Principles Board Opinion No. 16
(APB, 1970) permitted the use of either the purchase method or pooling of interests method when accounting for business combinations. Aboody, Kasznik and Williams (2000) find that for acquisitions in which there is a large step-up in target net assets, CEO’s with earningsbased compensation are more likely to choose pooling to avoid the earnings penalty. To account for the effects, if any, of this pooling versus purchase choice, we add a dummy variable to our basic regression equation and re-estimate our regressions. The results
(unreported) indicate that in most cases, the variable is not significant, and in all cases, our findings remain qualitatively unchanged.
12
6.
Conclusion
We examine the relationship between post-acquisition earnings quality and motives for corporate acquisitions. We infer two types of merger motives (synergy and agency) using the stock market’s reaction to the merger announcement. We define earnings quality as closeness-to-cash and argue that an earnings stream that is a better predictor of future operating cash flows is of higher quality. Our study provides evidence that synergymotivated acquisitions produce, on average, significantly higher quality earnings than agency-motivated acquisitions. Our results are robust to multiple definitions of operating earnings and cash flows, as well as an alternative method for imputing merger motives.
12 SFAS No. 141, Business Combinations , eliminated the use of the pooling of interest method when accounting for business combinations. Since SFAS No. 141 was not issued until February 2001, the companies included in our sample were unaffected by this Standard.
14

Our findings are consistent with the notion that managers who pursue synergy or agency-motivated acquisitions do not face the same economic environment and incentive schemes both before and after acquisition transactions are consummated. Our results are also consistent with the notion that incentives to manipulate earnings are greater for agencymotivated acquisitions when compared to those of synergy-motivated acquisitions.
Though our results may only be generalized to those firms that have completed merger transactions, our approach offers a methodology that can be used to help predict, ex- ante, those acquirers that will likely produce an earnings stream of higher or lower quality.
Our study also operationalizes an earnings quality metric that is grounded in a closeness-tocash construct, which is useful in assessing post-event performance in circumstances where the fundamentals of the firm have changed (e.g.; acquisitions, divestitures, reorganizations, etc). It also suggests that the predictive ability of GAAP-based earnings is useful in assessing, from an accounting perspective, whether a merger was successful or not.
15

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Table 1 – Criteria used to identify the type of acquisition based on the stock market
reaction to the acquisition announcement
Cumulative Abnormal Returns (CAR) accruing to the acquirer and the target at the acquisition announcement are used to identify motive or type of the acquisition. Total CAR represents the combined CAR of the acquirer and the target, weighted by their market values.
The criteria used to identify the type of acquisition based on the CAR are the following:
Acquirer CAR
Positive Negative
Total CAR
Positive Synergy Hubris
Negative Undefined Agency
We focus on synergy and agency-motivated takeovers, as highlighted in italics above.
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Table 2 – Sample selection
Mergers are identified using the Securities Data Company ( SDC ) database. Stock price data were obtained from the Center for Research in Security Prices ( CRSP ) database. Financial statement data were obtained from COMPUSTAT .
All mergers of US public companies between 1987 and 1999
3,950
(1,396)
Mergers not involving companies from the financial sector (SIC code 6XXX)
Mergers with sufficient data
Mergers identified as either synergy or agency
Final sample after truncation of mergers with most extreme 1% of CFO or EARN
2,554
(1,430)
1,124
(203)
921
(14)
907
19

Table 3 – Descriptive statistics
Panel A: Classification of acquisition motive based on the stock market reaction to the
acquisition announcement
Cumulative Abnormal Returns (CAR) accruing to the acquirer and the target at the acquisition announcement are used to identify the motive or type of acquisition. Total CAR represents the combined CAR of both the acquirer and the target weighted by their market values. The initial reaction to the acquisition announcement is estimated by the calculating the cumulative abnormal returns (CAR) accrued to the acquirer and the target from five days prior to the acquisition announcement to five days following the announcement. The first group consists of acquisitions in which both the acquirer CAR and the total CAR (acquirer plus target) were positive. This group is consistent with synergy-motivated acquisitions. The second group contains acquisitions in which the acquirer CAR was negative and the total
CAR was positive. This group is consistent with cases of hubris. The third group contains acquisitions in which both the acquirer CAR and the total CAR were negative. This group is consistent with agency-motivated acquisitions. The fourth group consists of acquisitions in which the acquirer CAR was positive and the total CAR was negative. This group is undefined.
Acquirer CAR
Total CAR
Positive Negative
Positive
Synergy
457 (41%)
Hubris
152 (14%)
Negative
Undefined
51 (4%)
Agency
464 (41%)
We focus on synergy and agency-motivated takeovers, as highlighted in italics above.
Panel B: Firm characteristics – unscaled variables
The table presents means and medians for total assets (item 6 in Compustat ), EARN
(operating income - item 18 in Compustat ) and CFO (cash flow from operations - item 308 in
Compustat ). All variables are pooled for the three years following the acquisition. All values are in millions of dollars.
Total assets
EARN
CFO
All Synergy Agency
Mean Median Mean Median Mean Median
9,708
299
920
1,948 9,342
54
136
306
827
1,845
55
132
10,073
291
1013
2,090
54
142
20

Table 3 - Descriptive Statistics - continued
Panel C: Firm characteristics – scaled variables
The table presents means and medians for CFO, EARN, and ACC, where CFO is cash flow from operations (item 308 in Compustat ), EARN is operating income (item 18 in Compustat ) and ACC is total accruals (defined as the difference between EARN and CFO). All variables are pooled over three years following the acquisition and deflated by average book value of total assets (item 6 in Compustat ).
CFO
EARN
ACC
All Synergy Agency
Mean Median Mean Median Mean Median
0.082
0.072
-0.012
0.087 0.084
0.090 0.074
0.000 -0.012
0.092
0.092
0.081
0.069
0.001 -0.012
0.083
0.088
0.001
21

Table 4 – Earnings quality regressions
We estimate the equation CFO t+1
= +
1
CFO t
+
2
ACC t
+ t+1
, where CFO represents cash flow from operations (item 308 in Compustat ) and ACC is defined as the difference between
EARN (operating income after depreciation - item 178 in Compustat ) and CFO. All variables are deflated by average total assets (an average of item 6 in Compustat ). The motive for the acquisition is interpreted from the stock market reaction to the acquisition announcement as explained in section 3.1. Z-statistics compare regression R 2 s (synergy versus agency) following Harris, Lang and Moller (1994) and Cramer (1987).
Year following the acquisition t = 1 t = 2
Motive for the acquisition
Synergy Agency Synergy Agency Synergy Agency
0.032 0.029 0.032 0.045 t = 3
0.021 0.038
1
(t-value)
2
(t-value)
Adjusted R 2
N
Z-statistic
P-Value
0.745
(19.33)
0.184
(4.10)
0.465
428
1.21
0.728
(17.40)
0.173
(4.01)
0.412
0.1134
432
0.635
(17.06)
0.249
(6.55)
0.413
415
0.686
(13.73)
2.10
0.209
(4.78)
0.318
0.0180
410
0.810
(21.17)
0.341
(8.99)
0.579
343
(15.47)
3.34
0.629
0.310
(7.65)
0.422
0.0004
326
22