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The Influence of Takeover Protection on Earnings Management

Authors

  • Yijiang Zhao,

    1. The authors are respectively Assistant Professor of Accounting, School of Management, University of Alaska Fairbanks, and Steinhart Foundation Professor, School of Accountancy, University of Nebraska-Lincoln. This paper is based on one chapter of the first author's dissertation completed at University of Nebraska-Lincoln. The authors greatly acknowledge Martin Walker (editor), an anonymous referee, Arthur Allen, George McCabe, Mary McGarvey, faculty at University of Alaska-Fairbanks and University of Arkansas-Little Rock, and workshop participants at the 2005 Mid-Atlantic American Accounting Association conference, particularly Jayanthi Krishnan (discussant), for their helpful comments and suggestions.
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  • Kung H. Chen

    Corresponding author
    1. The authors are respectively Assistant Professor of Accounting, School of Management, University of Alaska Fairbanks, and Steinhart Foundation Professor, School of Accountancy, University of Nebraska-Lincoln. This paper is based on one chapter of the first author's dissertation completed at University of Nebraska-Lincoln. The authors greatly acknowledge Martin Walker (editor), an anonymous referee, Arthur Allen, George McCabe, Mary McGarvey, faculty at University of Alaska-Fairbanks and University of Arkansas-Little Rock, and workshop participants at the 2005 Mid-Atlantic American Accounting Association conference, particularly Jayanthi Krishnan (discussant), for their helpful comments and suggestions.
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  • They also thank Andrew Metrick for making the Governance Index and Blockholder Ownership datasets public, and Lucian Bebchuk for sharing his staggered board dataset.

* Address for correspondence: Yijiang Zhao, Assistant Professor of Accounting, School of Management, University of Alaska Fairbanks, Fairbanks, AK 99775, USA. e-mail: ffyz@uaf.edu

Abstract

Abstract:  We examine the relationship between takeover protection and earnings management. Existing theories suggest two contradictory effects of takeover protection on opportunistic earnings management: entrenchment theory suggests an exacerbating effect, whereas both alignment theory and quiet life theory posit a mitigating effect. We find that takeover protection is associated with lower levels of abnormal working capital accruals, lower levels of performance-adjusted abnormal accruals and timelier recognition of losses. Further tests show that takeover protection is associated with lower firm value, which contradicts alignment theory but supports quiet life theory. The results suggest that takeover protection allows managers to enjoy the quiet life and thus mitigates earnings management.

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