The disciplining role of financial statements: evidence from mergers and acquisitions of privately held targets

Corporate disclosure regulations are designed to protect investors and facilitate efficient capital allocation in the economy. One important corporate disclosure is audited financial reporting, which improves capital allocation (investment) decisions through its valuation implications and its governance/disciplinary role. In the context of mergers and acquisitions (M&As), the existing studies tend to focus on the valuation implications of the target firm’s accounting information. Whether target firms’ audited financial statements play a disciplining role in M&As remains unexplored. This study fills this gap.

The Securities and Exchange Commission (SEC) requires public acquiring firms to publicly disclose target firms’ audited financial statements when the M&A transaction meets certain disclosure thresholds. Because these financial statements are disclosed after the transaction is completed, they provide the acquiring firms’ outside shareholders with a tool, subsequently to the transaction, to monitor the acquiring firms’ M&A decisions. Therefore, I posit that this disclosure requirement imposes a disciplinary mechanism on the acquiring firms’ managers when they make M&A decisions.

Using this unique setting and hand-collected data from the SEC’s EDGAR system, I provide evidence consistent with the hypothesis that the disclosure of private targets’ audited financial statements disciplines the acquiring firms’ managers in making M&A decisions. Specifically, I find the disclosure of private targets’ financial statements is associated with more profitable M&A transactions. Several other alternative explanations cannot explain the main findings.