In recent years, a noticeable shift has emerged in the European market, where a growing number of companies are opting for private ownership instead of remaining publicly traded. This trend has been particularly observed as organizations strive for enhanced control and reduced pressures associated with public market expectations. However, prior to these voluntary delistings, many management teams engage in the practice of adjusting reported earnings, often to present a more favorable image of their companies or to facilitate smoother buyout processes.
The transition towards private ownership has roots tracing back to the collapse of the tech bubble in the early 2000s, gaining momentum following the 2008 financial crisis. As firms sought to escape the scrutiny of public markets, the emergence of private equity firms has played a significant role, providing fresh opportunities for restructuring and capital generation without the constant demands of public disclosure. In Europe, where ownership structures are typically more concentrated, actions such as leveraged buyouts (LBOs), management buyouts (MBOs), and minority freeze-outs are becoming increasingly prevalent.
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Analyzing earnings management practices
This article draws on a comprehensive analysis of 526 European firms conducted between 2005 and, aiming to shed light on how management behavior influences earnings reporting prior to voluntary delistings. Supervised by Wouter Creemers, PhD, CFA, this research was recognized with the third prize at the CFA Society Belgium’s Master Thesis Awards.
Understanding the flexibility of accounting standards
As the trend of voluntary delistings expands across Europe, it becomes crucial to scrutinize how management teams handle earnings in the lead-up to these transactions. Accounting frameworks, such as IFRS and US GAAP, offer a level of discretion that enables managers to manipulate reported outcomes through various accounting decisions or real business activities. This flexibility can result in a firm’s performance being portrayed inaccurately, thereby affecting decisions and contracts that rely on financial disclosures.
When such adjustments adhere to accounting standards and genuinely reflect business activities, they do not constitute fraud. Rather, they can serve as legitimate tools during corporate restructuring processes. Notably, it has been observed that management often engages in downward earnings management before embarking on voluntary delistings. In the context of LBOs, reducing reported earnings may effectively decrease the acquisition price, while in MBOs, it can secure a more advantageous buyout price for the management team.
Market reactions and implications
One of the central inquiries of this research is whether managers in Europe intentionally manage earnings downwards ahead of voluntary delistings and how the market reacts to these maneuvers prior to or around the announcement dates. By analyzing the performance of 526 European firms—half of which opted for voluntary delisting, while the other half remained publicly traded—this study utilized accounting and market data spanning from 2005 to.
To assess earnings management, abnormal current accruals were estimated using the DeFond and Park (2001) model. Furthermore, an event study was conducted to track cumulative abnormal returns (CARs) surrounding each announcement. To test the hypotheses, T-tests and ordinary least squares regressions were employed.
Key findings and stakeholder considerations
The findings indicate discernible patterns in the behavior of firms before announcing their delisting intentions. Interestingly, while aligning with previous research trends, this study did not uncover significant downward shifts in stock prices before these announcements.
These results carry vital implications for various stakeholders. It is essential for investors and other interested parties to understand how voluntary delisting decisions may impact financial reporting practices prior to announcements, allowing for more informed strategic choices and improved assessments of financial statement reliability.
Although the earnings management observed—whether through permissible accounting practices or real activity adjustments—does not violate legal standards, it nonetheless reveals a tendency toward opportunistic behavior among managers in firms preparing to go private. In light of these findings, regulators might consider enhancing disclosure requirements to ensure that financial reports more accurately depict a firm’s performance leading up to delisting.
Financial analysts and advisors should factor in the implications of delisting decisions on earnings management when conducting evaluations and formulating recommendations for clients. Previous studies have predominantly focused on the United States and the United Kingdom, making this research on European firms pivotal in broadening the geographic scope of the literature and enriching the insights on earnings management.
In conclusion, the outcomes of this analysis underscore the significant interplay between managerial decisions, financial reporting, and market responses in the context of voluntary delistings in Europe. This research not only enhances the understanding of earnings management but also provides practical insights for investors and regulatory bodies alike.
