Does the Threat of Takeover Discipline Managers? New Evidence from the Foreign Investment and National Security Act

Abstract

Competing theories and mixed results describe the effect of the takeover market on managers’ earnings management incentives. I use the passage of the Foreign Investment and National Security Act (FINSA), which suppressed foreign investment in a subset of U.S. industries, to re-examine this relationship. I find that, after FINSA implementation, FINSA-affected firms record more income-increasing discretionary accruals. Firms that were more likely to be subject to takeover before FINSA drive this effect. This inference is robust to a wide variety of empirical specifications and discretionary accrual measures as well as to the use of firm fixed effects, model-free measures of earnings management and multiple placebo tests. Overall, these results suggest that a weaker market for corporate control accentuates earnings management.