Management Buyouts and Earnings Management

This study examines earnings manipulation in 87 management buyout cases during 1980–1987. Using a different research design than DeAngelo (1986), this paper shows that earnings changes for the sample are significantly lower than the industry median change in the year before the MBO. An examination of pre-MBO stock prices indicates a downward movement. This downward movement is systematically associated with pre-MBO earnings changes. Moreover, preannouncement declines in earnings are specific to MBOs. In the case of third-party takeovers, income did not decline in the preannouncement period. When this research design is applied to DeAngelo's (1986) sample, results consistent with earnings management are obtained. Taken together, the overall evidence favors the hypothesis that managers manipulated earnings downward prior to the MBO proposal. The potential benefit from earnings manipulation is estimated to be almost $50 million on average for the sample firms.