Does Financial Reporting Quality Attenuate the Agency Costs of Overvalued Equity?

• In Event: Financial Accounting and Reporting 3

Abstract

Managers of overvalued firms tend to pursue excessive acquisition strategies to meet the market optimism and strong corporate governance discourages value-destroying M&As. We find that financial reporting quality disciplines managers at the front-end of acquisition process and averts market-driven takeover stock bids. Our findings may be explained by the fact that high-quality financial reporting facilitates an effective board oversight, and managers can rationally anticipate the board to reject their opportunistic stock bids. We identify equity overvaluation with an exogenous trading pressure from mutual fund inflows to alleviate alternative interpretation of reverse causality. While the majority of M&A studies focus on merger performance, we focus on merger behavior (how financial reporting quality disciplines managers to avert the market-driven takeover bids). We contribute to the literature by demonstrating that high-quality financial reporting attenuates the agency costs of overvalued equity by mitigating managerial sub-optimal investment decisions and enhancing takeover efficiency in the market for corporate control.

Authors

• Steve C Lim, Texas Christian University

• Sangwan Kim, University of Massachusetts-Boston