Corporate Managerial Ability, Earnings Smoothing, and Acquisitions

Abstract

This paper examines whether high-ability managers’ earnings smoothing is motivated by the need to mitigate the adverse effects of heightened information asymmetry triggered by mergers and acquisitions (M&As) on managers’ reputation capital (job loss) and firm value. We document that acquirers led by high-ability managers engage in more pre-acquisition earnings smoothing and experience more significant announcement abnormal returns and operating performance in post-M&A periods than their low-ability counterparts. This result is consistent with the theory of managerial response to asymmetric information, amplified by M&As, where high-ability managers use earnings smoothing as a signaling device to ensure that the market quickly discovers their superior abilities, to increase acquirers’ future growth prospects and avoid the adverse effects of information asymmetry on managers’ job security and career prospects in a competitive executive labor market.

Keywords: Managerial ability, Earnings smoothing, Merger and acquisitions

JEL Classification: G14, G32, G34, M0, M20, M24