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    Can Auditors Mitigate Information Asymmetry in M&As? An...
    research summary posted February 24, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality 
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    Title:
    Can Auditors Mitigate Information Asymmetry in M&As? An Empirical Analysis of the Method of Payment in Belgian Transactions
    Practical Implications:

    Our findings provide support for the notion that a BigN quality effect reduces information asymmetry in the Belgian context. In addition, we illustrate that audit quality significantly affects a firm’s financial choices related to strategically important projects such as M&As. Finally, we also show that high-quality audits mitigate the market timing behavior of managers.

    For more information on this study, please contact Mathieu Luypaert.

    Citation:

    Luypaert, M. and T. Van Caneghem. 2014. Can Auditors Mitigate Information Asymmetry in M&As? An Empirical Analysis of the Method of Payment in Belgian Transactions. Auditing: A Journal of Practice and Theory 33 (1): 57-91.

    Keywords:
    mergers and acquisitions, audit quality, Big N auditor, method of payment
    Purpose of the Study:

    The need for external auditing stems from information asymmetry between the insiders and outsiders of the firm. The main purpose of an external financial statement audit is to enhance the credibility of the disclosed financial figures vis-à-vis potential investors by providing an independent certification of the information presented in the financial statements. In this study, we investigate the effectiveness of the external financial statement audit in reducing information asymmetry in the context of mergers and acquisitions (M&As) by analyzing the method of payment.

    We focus on two areas of information asymmetry:

    • First, bidders make an offer to target shareholders based upon their estimate of the target value but the target firm is better informed about its own value than the bidder. The bidder may solve this problem by making the payment to the target shareholders contingent upon future performance. This can be achieved through stock offers because the value of such offers depend upon how the market assesses the M&A, resulting in risk-sharing between the target and the acquirer. We argue that a high-quality external financial statement audit reduces the need for risk-sharing behavior.
    • A second information asymmetry relates to the value of the bidder. Because bidders have private information about their own value, they may try to exploit this information advantage by offering stock when they are overvalued. This might explain why stock offers are typically found to result in inferior returns for bidding firm shareholders. We contend that the certification of the bidder’s financial statements by a high-quality auditor limits the bidder’s incentives to use stock as a method of payment.
    Design/Method/ Approach:

    We use ordered probit analysis and binary regression analysis to investigate the impact of the external financial statement audit on the method of payment across a sample of 125 M&As between Belgian firms using data from the period 1997-2009. We believe Belgium to be an interesting setting in which to investigate auditor impact because an external financial statement audit is mandatory for large Belgian firms regardless of whether they are listed.  In addition, small firms can opt for a voluntary financial statement audit. 

    Findings:
    • We show that contingent payments are significantly less likely if the target firm is audited by a BigN auditor. This conclusion is valid under different specifications.
    • In addition, a BigN audit of the acquiring firm is found to reduce market timing behavior by acquirers.
    • Also, target shareholders are more likely to accept contingent offers when the acquirer’s financial statements are certified by a BigN auditor. 
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality