While restatement filings may seem to be signs of corporate governance failures and ineffective controls, a seven-year study of nearly 2,000 pairs of restating and non-restating U.S. firms found a 44 per cent difference in takeover bid likelihood over the 12 months following restatement – a 3.2 per cent likelihood for restating firms compared to a 5.7 per cent likelihood for non-restating firms.
In addition, for those restating firms that do receive takeover bids, such bids are more likely to be withdrawn or take longer to complete than for non-restating firms, and there is some evidence that deal value multiples are significantly lower for restating targets, said the study forthcoming in The Accounting Review.
The paper – “The economic consequences of financial restatement: evidence from the market for corporate control” – was authored by Amir Amel-Zadeh, University Lecturer in Finance at Cambridge Judge Business School, and Yuan Zhang of the Naveen Jindal School of Management at the University of Texas at Dallas.
The authors conclude that restatement, perhaps perversely, tends to shield management from takeover bids by scaring off bidders worried about more unexpected information that may emerge from restating firms.
“Higher information risk after restatement filings deter potential bidding firms from correcting inefficiencies within restating firms via the forces of the disciplinary takeover,” the research paper says.
This finding was reinforced by the fact that restatements due to both accounting errors and “irregularities” similarly reduce the likelihood of a takeover bid, suggesting that potential acquirers are “broadly concerned with information uncertainty” whether due to accounting error or management’s intentional misstatement.
“When we started to investigate, we expected that restating firms may be more likely takeover targets because restatements usually reflect problems in accounting, management and controls – all signs of weakness that the market often punishes with a significant downward revaluation of the firm, making it vulnerable to a takeover,” said Amel-Zadeh.
But what we found is that the information risk for potential acquirers is so high that it seems to override those other factors.
To assess the effect of restatements on takeover bid likelihood, the research looked at 1,963 pairs of restating and non-restating US firms between 2001 and 2008 matched on various factors – in order to control for such factors as market size, return on assets, leverage, sales growth and price-to-earnings ratio. These factors seek to ensure that firms in the control group are very similar in their propensity to be a restating firm based on firm characteristics, except that these companies did not file restatements.
Even without applying these controls, there is a similarly higher likelihood of takeover bids for non-restating firms, providing further confidence that restatement rather than other company factors is the reason for the difference in takeover bid likelihood.
The research only considers deals in which the acquirer seeks to purchase 100 per cent of a public target, so the acquirer does not have access to private information prior to the bid.