Searching for the Motives and Effectiveness of Chinese Mergers and

Acquisitions
Junxi Zhang and Xiaokun Wang*
School of Economics and Finance
The University of Hong Kong

Abstract
This study researches the M&A motives and their effectiveness by analyzing the
relationship between corporate governance, earnings management and the
performance of acquiring firms. We assume that if the long-term performance and
corporate governance of acquiring firms are significantly improved, M&As are driven
by the synergy motive; If the long-term performance of acquiring firms decreases
significantly and earnings management is obvious, M&As are driven by the agency or
hubris motive. The empirical evidence suggests that the long-term performance of
acquiring firms decreases significantly. Corporate governance of acquiring firms is
not improved and has no significant effect on the operating performance. However,
earnings management is very obvious and has significant effect on the short-term
performance of acquiring firms. Furthermore, the market reaction to acquisitions is
negative. Therefore, M&As in Chinese listed companies are mainly driven by agency
or hubris motive, and the synergy effect is not realized basically.

Keywords: M&A Motives, Operating Performance, Market Performance, Earning

Management, Corporate Governance.

We acknowledge the data support from the Center for China Financial Research (CCFR) in School of Economics
and Finance of the University of Hong Kong.
Correspondence Address: School of Economics and Finance, the University of Hong Kong, Pokfulam Road, Hong
Kong. Phone: (852)2857-8502. Fax: (852)2548-1152. E-mail: jjzhang@econ.hku.hk
1

I. Introduction
Since 1990s, the bull stock market and great technological innovation in the U.S. have
sparked a new wave of mergers and acquisitions. It involved large number of deals in
many industries with great dollar volumes. The famous cases include HP and Compaq,
Oracle and PeopleSoft, and SBCs merger with AT&T etc. In January of 2005, P&G
bought Gillette for 57 billions, which made this wave of M&A to its peak. Through
over ten years development, Chinese stock market has become the eighth largest in
the world. As an important means of corporate restructuring, mergers and acquisitions
are more and more employed by Chinese listed companies to fulfill their strategic
objectives. According to the data of CSMAR (Chinese Stock Market & Accounting
Research Database), 149 listed companies launched 214 M&As1 with the volume of
115 billion yuan in 1998. In 2000, 244 listed companies launched 376 M&As with the
volume of 435 billion yuan. Even more, these numbers reached to 352, 540 and 520
respectively in 2003. Therefore, mergers and acquisitions are crucial to the
development of Chinese listed companies, and also have great implications to the
government and its regulatory authorities.

In China, the government and regulatory authorities always encourage listed

companies to realize the synergy effect and enhance the firm value through M&As.
However, due to the short history of securities market and incompleteness of relevant
laws and regulations, some listed companies launch M&As by special motives. For
example, controlling shareholders use M&As to tunnel listed companies, and local
governments force listed companies to acquire bankrupting firms. These M&As are
not market-oriented activities and harmful to the development of listed companies and
securities markets.

In order to effectively regulate the M&As in listed companies, the motives of M&As
should be identified and analyzed. Researchers argue that different M&A motives lead
to different firm performances, so they can identify the motives from the perspective
1

Acquisitions include acquisitions of share and acquisitions of asset.

2

of firm performance. The empirical studies on the performance of M&A firms can be
divided into two categories: one is centered at the stock market return and the other
focuses on the operating performance. An important assumption of the first method is
the market efficiency, which remains a problem in Chinese stock markets. On the
other hand, some indicators of operating performance are prone to be manipulated.
Therefore, we need other evidences than the firm performance to identify the M&A
motives of Chinese listed companies.

This paper provides a new way to investigate the motives and their effectiveness on
the performance of acquiring firms, especially from the perspectives of corporate
governance and earnings management. We assume that if the long-term performance
and corporate governance of acquiring firms are significantly improved, M&As are
driven by the synergy motive; If the long-term performance of acquiring firms
decreases significantly and earnings management is obvious, M&As are driven by the
agency or hubris motive. The empirical results of this paper suggest that the long-term
performance of acquiring firms drops significantly and the corporate governance does
not change much, but earnings management is very obvious which has significant
effect on the firms performance. Therefore, M&As in Chinese listed companies are
mainly driven by the agency or hubris motive, and the synergy effect is not realized
basically.

This paper is organized as follows. Section II reviews the relevant literature and
proposes the hypotheses. Section III describes the data and sample, as well as the
research design. Section IV tests the hypotheses by studying the mechanisms of
corporate governance and earnings management, as well as their effects on the
performance of acquiring firms. Finally, we conclude in Section V.
II. Literature Review and Hypotheses
The performance of M&A firms has been widely studied in the financial economics.
Although many studies investigate stock returns around acquisitions, few studies
3

focus on changes in the operating performance. Perhaps the most notable study in this
field is by Healy et al. (1992). They find that cash flow performance improves
following acquisitions. However, following the research design prescribed by Barber
and Lyon (1996), Ghosh (2001) does not find evidence of improvements in the
operating performance following acquisitions. In contrast to the inconsistent empirical
results about the operating performance of M&A firms in other countries, a clear
conclusion about Chinese listed companies is reached by most researchers. For
example, Feng and Wu (2001) use sales to asset, return of asset, earning per share and
return of equity to measure the operating performance of acquiring firms between
1994 and 1998 and conclude that it increases in the announcement year and the next
year then decreases in the following years. Wan et. al. (2001) select sales growth,
earning before tax, earning after tax and return of equity to investigate the operating
performance of acquiring firms between 1997 and 1999, and find the similar empirical
results. In these studies, the changes of the operating performance after M&A are not
significant, which means that the event does not have material effect on the operating
performance. The study of Li and Chen (2003) further prove this point. The above
empirical studies rely heavily on the profitability indicators and use old samples of
M&As. Thus, this paper uses more comprehensive indicators to evaluate the effect of
recent M&As on the operating performance of Chinese listed companies. Furthermore,
we use Tobins q to measure the market valuation of acquiring firms, which also
reflects the market reaction to M&A event.

Why firms engage in mergers and acquisitions? In general, three major motives of
M&As have been advanced in the literature: the synergy motive, the agency motive
and the hubris motive (Berkovitch and Narayanan, 1993). The synergy motive
suggests that M&As occur because of economic gains that result from merging the
resources of two firms. The agency motive suggests that M&As occur because they
enhance the acquirer managements welfare at the expense of acquirer shareholders.
The hubris hypothesis maintains that M&As are motivated by managers mistakes in
evaluating target firms even when there is no synergy. Theoretically, M&As are value
4

increasing transactions for target firms in spite of which motives. However, for
acquiring firms, the agency and hubris motive have the negative effect on the firm
value. Although the synergy motive has the positive effect, it needs a long term to
work.

Some researchers try to identify M&A motives from the perspective of firm
performance. For example, Malatesta (1983) finds that acquisitions are value
increasing transactions for target firms but value decreasing transactions for acquiring
firms and concludes that acquisitions are motivated by agency. Berkovitch and
Marayanan (1993) distinguish among three M&A motives by investigating the
correlation between target and total gains. They argue that this correlation should be
positive if synergy is the motive, negative if agency is the motive, and zero if hubris is
the motive. They find that synergy is the primary motive in takeovers with positive
total gains and agency is the primary motive in takeovers with negative total gains.

The synergy motive, agency motive and hubris motive have some explaining power to
M&As in Chinese listed companies, especially in the situation that most listed
companies have non-tradable shares controlled by state owners. Some studies explore
the M&A motives of Chinese listed firms and provide valuable insights. Zhang (2003)
proposes the hypothesis of value transfer and redistribution dominated by institutional
factors, but he dose not test it empirically. Li et. al. (2005) investigates the effect of
tunneling or propping motives of controlling shareholders and local government to the
long-term performance of listed companies. Their result suggests that the M&As
driven by motives of avoiding deficit or rationing shares can enhance the companies
operating performance in short term. When companies have not such motives, the
M&As are basically tunneling activities which will damage the companies value but
have no significant influences to their operating performance. However, this study
only captures the M&A motive of avoiding deficit or rationing shares, and tunneling
or propping can be viewed as one kind of agency problem.

The existing empirical evidence does not clearly distinguish among different M&A
motives of Chinese listed firms. Although the method of Berkovitch and Marayanan
(1993) is useful, it cant be applied to M&As of Chinese listed firms due to the fact
that most of target firms are not listed and the relevant data are unavailable. This
paper tries to identify the M&A motives of Chinese listed firms by investigating the
relationship between corporate governance, earnings management and the long-term
performance of acquiring firms.

Specifically, for acquirers driven by the synergy motive, M&As are value increasing
transactions. And the gains can be traced to efficiency increase, operating synergy,
diversification and financial synergy etc. (Weston et al., 2001). The synergy gains will
be reflected in the improvement of operating performance such as sales increase, cost
reduction, and profit enhancement, but need a long time to work. Furthermore,
corporate governance and firm performance work interactively. As suggested by
Dennis and McConnell (2003), corporate governance is the set of mechanisms-both
institutional and market based-that induce the self interested controllers of a company
to make decisions that maximize the value of the company to its owners. A firms
various corporate governance practices shape its behavior and eventually affect its
stock market performance and operating performance (Liu, 2005). We argue that the
synergy gain for acquiring firms cannot be realized without the good corporate
governance. On the other hand, M&As driven by the synergy motive may induce
improvements in corporate governance of acquiring firms. Under the rational market
expectations, the market reaction to the M&As driven by the synergy motive will be
positive. Therefore, we make the following hypothesis:

HI Ceteris Paribus, if M&As are driven by the synergy motive, the long-term
performance and corporate governance of acquiring firms will be improved
significantly, and corporate governance has significant effect on the long-term
operating performance of acquiring firms, and the market reaction will be
positive.
6

On the other hand, if acquirers driven by the agency or hubris motive, M&As are
value decreasing transactions. Due to managers self interest or overestimation of
target firms, M&As are detrimental to the operating performance of acquiring firms.
However, in order to keep their positions or reputation, the acquirers managers have
strong incentives to disguise the loss induced by M&As. Under this circumstance,
earnings management is a necessary choice for managers of acquiring firms. Earnings
management, the practice of manipulating earnings to show temporarily improved
financial performance, has been found around significant corporate events, including
mergers and acquisitions. Consistent with Erickson and Wang (1999), Louis (2004)
finds strong evidence suggesting that acquiring firms overstate their earnings reports
in the quarter preceding the announcement of a stock swap acquisition. Nevertheless,
earnings management is not costless and only works to the short term operating
performance. Under the rational market expectations, the market reaction to the
M&As driven by the agency or hubris motive will be negative. Thus, we provide the
following hypothesis:

HIICeteris Paribus, if M&As are driven by the agency or hubris motive, the
long-term performance of acquiring firms will decrease significantly, and
earnings management by managers will be obvious and has significant effect on
the short-term operating performance, and the market reaction will be negative.

III. Sample Selection and Research Design

A. Sample Selection
The main data source of this study is China Stock Market & Accounting Research
Database (CSMAR), which is compiled according to the format of CRSP and
Compustat. Since CSMAR is an authoritative and professional financial database
about Chinese listed companies, it is adopted by Wharton Research Data Service
(WRDS). We mainly use three subsets of CSMAR including Mergers and
Acquisitions Database, Financial Statements Database and Corporate Governance
7

Database. Other sources such as Genius Database will also be employed as the
calibration and supplement to CSMAR.

Our sample is drawn from CSMAR Mergers and Acquisitions Database using the
following criteria:

The transaction is classified either as an acquisition of share or an acquisition of

asset;

The transaction is listed as successful and completed;

The announcement date2 of the acquisition lies between January 1, 2000 and
December 31, 20023;

If a listed company launched multiple acquisitions in this period, we only use the
first transaction4.

Our full sample is composed of 618 acquisitions. Table 1 shows the summary
statistics for sample firms about the yearly distribution, location of stock market and
type of acquisition. Since we exclude the possibility of multiple acquisitions by an
acquirer, one firm in our sample corresponds to one acquisition. That is the reason
why the amount of acquisitions decreases from 2000 to 2002. Moreover, all sample
firms only have A shares.

If it is not disclosed, we use the completion date as the substitute.

The sample period is restricted because the employee data is only available for the period from 1999 to 2003.
4
This criterion ensures that the performance of acquiring firms is only affected by a single acquisition.
3

Table 1: Summary Statistics on Acquisitions, 2000-2002

The numbers in the table are the amounts of acquisitions or
acquiring firms.
Year
1998

1999

2000

Total

Location of Stock Market

Shanghai
Shenzhen

134
109

137
92

102
44

373
245

Type of Acquisition
Acquisition of Share
Acquisition of Asset

183
60

141
88

84
62

408
210

Total

243

229

146

618

B. Research Design
B1. Measuring the Performance of acquiring firms
Drawing heavily on the work of Hu, Song and Zhang (2005), we use four groups of
indicators, i.e., production, profitability, cost and productivity, to measure the
operating performance of acquiring firms. Compared with former studies which rely
heavily on indicators of profitability, for example, Healy et al. (1992) and Ghosh
(2001), the performance indicators employed in this paper are more comprehensive.
Production is defined as sales revenue. Profitability is the most comprehensive
measure of firm efficiency and consists of profit, return of assets (ROA)5 and return of
sales (ROS) here. We abandon return of equity (ROE) because there are many cases
where both return and equity of an acquirer are negative and eliminating those firms
will bias the results. The cost indicators consist of total cost, total fee, total cost per
sales (COS) and total fee per sales (FOS). The total fee is defined as the sum of sales
fee, financial fee and administrative fee. The total cost per sales and total fee per sales
are the mirror indicators of profitability, reflecting a firms efforts in cost reduction.
The last category of indicators is productivity, including sales per worker (SOW), cost
per worker (COW) and profit per worker (POW). Productivity is another measure of
firm efficiency that is particularly sensitive to changes in the workforce and capital
stock. Totally, we have eleven indicators on the operating performance.
5

It is computed as the earnings before interest and tax over total value of assets.
9

Furthermore, we use Tobins q to measure the market valuation or performance of

acquiring firms, which also reflects the market reaction to M&A event. Tobins q is
the widely used measure of valuation for listed companies and normalized with
respect to the firm size. Following Chung and Pruitt (1994), Tobins q is defined as:

Tq =

MVCS + BVLTD + BVINV + BVCL BVCA

BVTA

(1)

Where MVCS is the market value of the firms common stock shares, BVLTD is the
book value of the firms long-term debt, BVINV is the book value of the firms
inventories, BVCL is the book value of the firms current liabilities, BVCA is the book
value of the firms current assets, and BVTA is the book value of the firms total assets.
Adopting the method of Bai et al. (2004), we adjust the measurement of Tobins q to
take account of illiquidity discount of 70% and 80% in the Chinese stock markets.
Specifically, we multiply the amount of tradable shares by the market price and the
amount of non-tradable shares by 30% and 20% of the market price when calculating
MVCS. Finally, we have two measurements of Tobins q denoted as Tq70 and Tq80,
respectively.

B2. Measuring corporate governance

Basing on the work of Bai et al. (2004), we employ eight corporate governance
variables to capture the control-based governance model adopted in Chinese listed
firms. As stated in Bai et al. (2004), there are two types of corporate governance
mechanisms in China. The first type consists of internal mechanisms, e.g., the
ownership structure, executive compensation, the board of directors, and financial
disclosure. The second are external mechanisms, e.g., the effective takeover market,
legal infrastructure, and product market competition. To capture the ownership aspect
of corporate governance, they use the stake of the largest shareholder to measure the
largest shareholders interest in a firm. Moreover, they uses a dummy variable, which
10

equals to 1 if a firm has a parent company and 0 otherwise, to reflect the scope for
tunneling of the largest shareholder. With respect to the board of directors, they create
a dummy variable that equals to 1 if the CEO is the chairman or vice chairman of the
board of directors and 0 otherwise. To measure the degree of outside control of the
board, they take the ratio of outside directors, who are not members of the
management team, to inside directors. Regarding executive compensation, they
choose an alternative variable, i.e., the percentage of shares hold by the top executives
of the firm, to capture the alignment of interests between managers and shareholders.
Regarding financial transparency, they believe that companies that issue H shares or B
shares must adopt international accounting standards therefore have reliable
information. To capture this effect, they use a dummy variable that equals 1 if a
company has H shares or B shares and 0 otherwise. Since an active corporate control
market does not exist in China, they measure the market for corporate control by the
concentration of shares in the hands of the second to the tenth shareholders. In
addition to these variables, we use the percentage of state-owned shares to capture the
effect of government.

The corporate governance variables are defined as follows.

(1) CEO Whether the CEO is the chairman or vice chairman of the board of
directors.
(2) Out The proportion of outsider directors, i.e., the ratio of the number of
directors without pay with respect to the total number of directors.
(3) Top_executive Shareholding percentage by the top executives of the firm.
(4) Top1 Shareholding percentage of the largest shareholder.
(5) Parent Whether the firm has a parent company.
(6) Concentration Concentration of shareholding in the hands of the 2nd to the 10th
largest shareholders, i.e., sum of squares of the shareholding
percentage by the 2nd to the 10th largest shareholders, and then
take logarithm.
(7) State_control The percentage of state-owned shares.
11

(8) Bh Whether the firm has H shares traded in Hong Kong Stock Exchange or B
shares traded in Shanghai or Shenzhen Stock Exchange.

Since the above eight variables represent the internal and external mechanisms of
corporate governance separately, it is important to form a composite measure of
corporate governance for the listed firms. Following Bai et al. (2003), we use the
principal component analysis (PCA) to establish the corporate governance index,
which is represented by the first principal component of the PCA. The central idea of
PCA is to reduce the dimensionality of a data set consisting of a large number of
interrelated variables, while retaining as much as possible of the variation present in
the data set. This is achieved by transforming to a new set of variables, the principal
components (PCs), which are uncorrelated, and which are ordered so that the first few
retain most of the variation present in all of the original variables (Jolliffe, 2002).
Since the eight corporate governance variables are highly and significantly correlated6,
the PCA method is very suitable and reliable in this condition.

B3. Estimating Earnings Management

Usually, the discretionary accruals are widely used in the literature to represent the
level of earnings management. Many models for measuring discretionary accruals
have been developed based on the relation between total accruals and hypothesized
explanatory factors, for example, Healy (1985) model, DeAngelo (1986) model, Jones
(1991) model, modified Jones model (Dechow, Sloan and Sweeney, 1995),
cross-sectional Jones model (DeFond and Jiambalvo, 1994), cross-sectional modified
Jones model (DeFond and Jiambalvo, 1994) and Kang & Sivaramakrishnan (1995)
model. The empirical results for American firms suggest that cross-sectional Jones
model and cross-sectional modified Jones model are more powerful than other models
to detect earnings management (Subramanyam, 1996; Bartov, Gul and Tsui, 2000).
Using the data of Chinese listed companies, Xia (2003) offers a comprehensive
analysis on the power of nine earnings management models and finds that
6

The details are presented in Table 3.

12

cross-sectional Jones model is the most efficient one. Therefore, we use

cross-sectional Jones model and cross-sectional modified Jones model to estimate
discretionary accruals in this paper.

Specifically, these models apply cross-sectional regression on accruals of firms in the

same industry to obtain predicted values as non-discretionary accruals. We further
divide the discretionary accruals calculated by the modified Jones model into the
discretionary current accruals and the discretionary long-term accruals according to
Teoh et al. (1998). Current accruals are adjustments involving short-term assets and
liabilities that support the day-to-day operations of the firm. In contrast, long-term
accruals are adjustments involving long-term assets such as depreciation and
amortization. Guenther (1994) argues that managers have greater discretion over
current accruals than over long-term accruals.

Now, we have four kinds of discretionary accruals to measure earnings management

of the firm. They include discretionary total accruals by Jones model (DTAC),
discretionary total accruals by modified Jones model (MDTAC), discretionary current
accruals by modified Jones model (MDCA), and discretionary long-term accruals by
modified Jones model (MDLA). The details of computation are presented in the
appendix. It should be noted that the cross-sectional approach automatically adjusts
for changing industrywide economics conditions which influence accruals of earnings
management independently. Therefore, it is unnecessary to adjust above four
discretionary accruals by their industry medians7.

IV. Results
A. The Performance of Acquiring Firms
To examine the effect of M&A event on the performance of acquiring firms, we
7

Kothari et al. (2004) argue that the existing methods of estimating discretionary accruals are biased toward
rejecting the null hypothesis of no earnings management. They recommend adjusting the discretionary accruals by
the average discretionary accruals of a portfolio matched on prior-year return-of-asset (ROA) and industry. We
abandon this method because on average each portfolio only has ten firms in our sample and this will result in the
small sample bias of estimates.
13

comparing eleven operating performance indicators and two market performance

indicators of acquiring firms over the year of the acquisition announcement, the
preceding year, and the year after. The median of each indicator, the time-series
differences of indicators and their statistical tests are reported in Table 2. It is obvious
that profitability of acquiring firms decreases significantly after the acquisition,
especially for indicators of ROA and ROS. For example, the median ROS decreases
from 11.01% in the preceding year to 5.52% in the year after. Moreover, sales rise
significantly after the acquisition. However, the large increase in cost, particularly in
the total cost and total fee, offsets sales increase and underpins the spectacular loss in
profitability. For the productivity, although there is a dramatic improvement in SOW
after the acquisition, ROW reduces 1450 Yuan in the announcement year and 6660
Yuan further in the year after due to the significant increase of COW after the
acquisition. All of above suggest that there are significant post-acquisition decreases
in the operating performance of acquiring firms. This finding is in sharp contrast with
the results of former studies, such as Feng and Wu (2001) and Wan et al. (2001). The
value of acquiring firm also suffers significant loss after the acquisition, which can be
reflected in the change of Tobinq. For example, the median Tq70 decreases from 1.4
in the preceding year to 1.0 in the year after.

Therefore, the operating performance and market performance of acquiring firms

decreases significantly after the acquisition, especially in the long term. We suspect
that M&As of Chinese listed companies are mainly driven by agency or hubris motive.
To further prove this speculation, we need other evidence. In the next section, we will
analyze M&A motives form the perspective of corporate governance.

14

Table 2: Time-Series Performance Comparison of Acquiring Firms

ROA is return of assets and ROS is return of sales. The total fee is defined as the sum of sales fee, financial fee and administrative fee.
COS is total cost per sales and FOS is total fee per sales. SOW, COW and ROW are sales per worker, cost per worker and profit per
worker, respectively. Tq70 and Tq80 are Tobinqs calculated by taking account of illiquidity discount of 70% and 80% in the Chinese
listed companies, respectively. The numbers in the table are medians. *, ** and *** represent significance level at 10%, 5% and 1%
respectively.
Items

Indicators

Unit

The year before

The announcement year

The year after

(1)

(2)

(3)

Wilcoxon
(2)-(1)

two-sample test

Wilcoxon
(3)-(1)

z-value

two-sample test
z-value

Production

Sales

100 million

4.43

5.37

6.49

0.95

3.070***

1.11

2.613***

Profitability

Profit

100 million

0.47

0.47

0.38

0.00

0.251

-0.09

-3.002***

ROA

Ratio

6.63%

5.97%

4.96%

-0.66%

-4.060***

-1.02%

-4.725***

ROS

Ratio

11.01%

8.64%

5.52%

-2.38%

-3.692***

-3.12%

-6.427***

Total Cost

100 million

3.12

3.79

4.93

0.67

2.849***

1.14

2.670***

Total Fee

100 million

0.59

0.78

1.03

0.19

4.253***

0.25

5.097***

COS

Ratio

74.80%

75.48%

76.94%

0.68%

0.525

1.46%

1.819*

FOS

Ratio

14.23%

14.52%

16.07%

0.29%

1.106

1.55%

3.007***

SOW

1000

285.08

326.52

374.04

41.44

2.625***

47.52

2.403**

COW

1000

197.60

236.83

282.94

39.23

2.567***

46.11

2.743***

ROW

1000

29.87

28.42

21.76

-1.45

-0.426

-6.66

-2.799***

Tq70

Ratio

1.4

1.3

1.0

-0.1

-1.779*

-0.3

-9.617***

Tq80

Ratio

1.2

1.2

0.9

0.0

-1.319

-0.3

-9.193***

Cost

Productivity

Market Performance

15

B. Corporate Governance and the Performance of Acquiring Firms

Given the definitions of eight corporate governance variables in the previous section, the
value of each variable for sample firms from 1999 to 2003 is collected or calculated
according to the CSMAR Corporate Governance Database. In order to get a consistent and
comprehensive measurement of the corporate governance mechanisms of acquiring firms,
we use the principal component analysis (PCA) to establish the corporate governance index,
which is represented by the first principal component of the PCA. Since different corporate
governance variables are measured in different units, we use the correlation matrix to derive
the first PC. The correlation coefficients between corporate governance variables are
presented in Table 3. It suggests that most of variables are significantly correlated, so the
PCA method is very suitable and reliable in this condition. Table 4 shows the factor loadings
from the first principal component of the PCA. It indicates that among the eight corporate
governance variables, Concentration, Top1, Out, Bh, Top_executive and state_control are
the more important components in the corporate governance index. The other two variables,
Ceo and Parent, are less important components. The sign and significance of each factor
loadings are consistent with the result of Bai et al. (2003).

16

Table 3: Correlation Coefficients between Corporate Governance Variables

CEO denotes whether the CEO is the chairman or vice chairman of the board of directors. Out
is the proportion of outsider directors. Top_executive represents the percentage shareholding by
top executives of the firm. Top1 is the shareholding percentage of the largest shareholder.
Parent denotes whether the firm has a parent company. Concentration is the sum of squares of
the shareholding percentage by the 2nd to the 10th largest shareholders. State_control is the
percentage of state-owned shares. Bh is Whether the firm has H shares or B shares. p-values are
in parentheses
Variables

CEO

Out

Out

Top_executive

Top1

Parent

Concentration

State_control

-0.123
(0.000)

Top_executive
Top1
Parent
Concentration
State_control
Bh

0.024

-0.047

(0.071)

(0.001)

-0.053

-0.075

-0.082

(0.000)

(0.000)

(0.000)

-0.086

0.088

-0.134

0.074

(0.000)

(0.000)

(0.000)

(0.000)

0.016

0.120

0.048

-0.602

0.002

(0.248)

(0.000)

(0.000)

(0.000)

(0.909)

0.024

-0.047

-0.072

0.056

-0.131

-0.040

(0.077)

(0.001)

(0.000)

(0.000)

(0.000)

(0.003)

-0.013

0.023

-0.017

-0.045

0.059

0.123

0.016

(0.321)

(0.096)

(0.199)

(0.001)

(0.000)

(0.000)

(0.236)

Table 4: Factor Loadings of the Corporate Governance Index

Variables

Factor Loading

CEO

0.044

Out

0.190

Top_executive

0.117

Top1

-0.669

Parent

-0.028

Concentration

0.679

State_control

-0.108

Bh

0.166

We have argued that if M&As are driven by the synergy motive, the long-term performance
and corporate governance of acquiring firms will be improved significantly. To understand
the evolution of corporate governance in acquiring firms, we compare the corporate
governance index over the year of announcement, the year before and the year after. The
17

result in Table 5 suggests that corporate governance of acquiring firms does not change
significantly after the acquisition. Since acquisitions do not induce improvements in
corporate governance of acquiring firms, we speculate that acquisitions of Chinese listed
companies are not driven by the synergy motive.
Table 5: Time-Series Corporate Governance Comparison of Acquiring Firms
The numbers in the first row are mean values and numbers in the second row are
medians. T test and Wilcoxon two-sample test are applied to mean values and medians
respectively. *, ** and *** represent significance level at 10%, 5% and 1%
respectively.
Variables

CG_index

The year

The announcement

The year

before

year

after

(1)

(2)

(3)

0.055

0.094

0.055

0.039

0.482

-0.039

-0.510

0.183

0.224

0.235

0.041

0.123

0.011

0.063

(2)-(1)

t/z
value

(3)-(2)

t/z
value

To further prove our speculation, we test the relationship between corporate governance
index and the operating performance of acquiring firms. If acquisitions do not induce
improvements in corporate governance of acquiring firms, the change in corporate
governance index is expected not to be related to the change in the operating performance of
acquiring firms. To perform this test, we first calculate the differences of performance
indicators and corporate governance index between the announcement year and the year
before, then regress the changes in eleven performance indicators on the change in corporate
governance index respectively.

Since corporate governance and operating performance always work interactively, there may
be the endogeneity problem in the regression model. We address this problem by using the
two stage least square (2SLS) regression model. For the endogenously determined variable,
we need an instrumental variablea variable that is correlated with the variable of interest,
but is ideally uncorrelated with the error term. Here, we use the floating ratio, the percentage
of tradable shares, as the instrumental variable for the corporate governance index. Wang and
Xu (2005) suggest that firm-specific floating ratio is a good proxy for expected corporate
governance in China, which helps to predict a firms future cash flow. In our sample, the
18

floating ratio is highly and significantly correlated to the corporate governance index.
Specifically, we apply the following 2SLS regression model:
PER( 1,0 ) = 0 + 1 Ln _ asset0 + 2D / A0 + 3 CG _ index( 1,0 ) + 4 Floating _ ratio( 1,0 ) +

(2)
Where PER is the variable for the operating performance of acquiring firms measured by
eleven indicators described above9. Ln_asset and D/A are control variables for size and risk,
which are proxied by the natural logarithm of book value of total assets and debt to asset
ratio in the announcement year, respectively. CG_index represents the corporate governance
index and Floating_ratio is an instrumental variable for CG_index. (-1,0) denotes the
changes of variables from the year before to the announcement year.

The regression results are reported in Table 6. As expected, the coefficient of CG_index is
insignificant in every regression. It is very clear that the change of corporate governance
index have no significant effect on the change of operating performance of acquiring firms.
We also take account of the possibility that corporate governance affects operating
performance gradually. Thus, we replace the change of operating performance from the year
before to the announcement year with that from the announcement year to the year after in
the equation (2), keeping other variables unchanged. This new regression will capture the
effect of the change of corporate governance index on the lag change of operating
performance of acquiring firms. Table 7 exhibits the similar result with Table 6 that none of
coefficient of CG_index is significant.

In addition, we test the relationship between corporate governance and market performance
of acquiring firms. In general, corporate governance should have positive effect on the firms
market performance, which has been proved by Bai et al. (2004). Here, we regress the
market performance on the corporate governance index cross-sectionally for a given year in
the estimation window, and compare the change of coefficient. From this, we can judge the
market reaction to the M&A event. Under the rational market expectations, the market
9

In order to account for the industry effect, we use the industry-adjusted performance indicator in the regression which is
calculated as the difference between the gross value and the median value of firms in the same industry, hereafter.
19

reaction to the M&As driven by the synergy motive will be positive. Specifically, we apply
the following 2SLS regression model:

PERi = 0 + 1 Ln _ asseti + 2D / Ai + 3 CG _ indexi + 4 CG _ index _ sqri + 5 Floating _ ratioi + i

(3)
Where PER is the variable for the market performance of acquiring firms measured by Tq70
and Tq80. Tq70 and Tq80 are Tobinqs calculated by taking account of illiquidity discount of
70% and 80% in the Chinese listed companies, respectively. Ln_asset, D/A, CG_index and
Floating_ratio are defined in the same manner with equation (2). We also include the square
of CG_index, denoted by CG_index_sqr, to take account of the possibility that there may be
a nonlinear relationship between corporate governance and market performance. The
regression result is presented in Table 8. It suggests that in the year before acquisition,
corporate governance has significantly positive effect on the market performance of
acquiring firms, which is consistent with the finding of Bai et al. (2004). However, after the
acquisition, the magnitude and significance of this positive effect decrease gradually. In the
year after acquisition, corporate governance has no significant effect on the market
performance. This sends us a clear signal that the market does not believe the function of
corporate governance when a firm launches acquisitions. Therefore, the market reaction to
acquisitions is negative. We also note that the coefficients of CG_index_sqr are not
significant for most of regressions, which means that the relationship between corporate
governance and market performance is almost linear.

We have found evidence that the change of corporate governance of acquiring firms is not
significant and have no significant effect on the change of operating performance. In
addition, market reaction to acquisitions is negative. Together with the fact that the long-term
performance of acquiring firms decreases significantly, hypothesis I is proved to be false.
Therefore, M&As by Chinese listed firms are not driven by the synergy motive basically. In
the next section, we will further prove this judgment from the perspective of earnings
management.
20

Table 6: The Effect of the Change of Corporate Governance Index on the Change of Operating Performance of Acquiring
Firms-2SLS Regression
Ln_asset and D/A are proxied by the natural logarithm of book value of total assets and debt to asset ratio in the announcement year,
respectively. CG_index represents the corporate governance index and is an endogenous variable. Changes are computed as the differences
of variables between the announcement year and the year before. This table shows the result of the final stage of the 2SLS regression, so
the coefficients of instrumental variableFloating_ratio are not included. The absolute value of t statistics is in brackets. *, ** and ***
represent significance level at 10%, 5% and 1% respectively.
Variables

Sales

Profit

Unit

(Billion)

(Billion)

Ln_asset
D/A
CG_index
Constant

Obersevations

ROA

ROS

Total Cost

Total Fee

(Billion)

(Billion)

COS

FOS

SOW

COW

ROW

(10000)

(10000)

(10000)

2.118

0.053

0.019

0.131

1.808

0.242

-0.027

0.091

20.905

19.600

-2.378

[5.54]***

[0.99]

[2.28]**

[1.56]

[5.73]***

[5.00]***

[1.97]**

[1.09]

[1.50]

[1.64]

[1.17]

2.801

0.420

0.104

-0.108

2.685

-0.163

0.287

-1.651

132.126

108.538

1.978

[1.66]*

[1.79]*

[2.80]***

[0.29]

[1.93]*

[0.76]

[4.84]***

[4.50]***

[2.00]**

[1.92]*

[0.20]

-4.578

-0.252

-0.041

0.062

-3.301

-0.576

0.138

-0.270

121.003

93.671

17.962

[1.29]

[0.51]

[0.53]

[0.08]

[1.12]

[1.28]

[1.11]

[0.35]

[1.34]

[1.21]

[1.36]

-44.56

-1.212

-0.460

-2.800

-38.226

-4.881

0.431

-1.097

-481.504

-446.428

50.142

[5.61]***

[1.10]

[2.62]***

[1.59]

[5.82]***

[4.85]***

[1.53]

[0.63]

[1.65]*

[1.79]*

[1.18]

549

549

549

547

549

549

547

547

465

465

465

21

Table 7: The Effect of the Change of Corporate Governance Index on the Lag Change of Operating Performance of
Acquiring Firms-2SLS Regression
PER( 0,1) = 0 + 1 Ln _ asset 0 + 2D / A0 + 3 CG _ index( 1, 0 ) + 4 Floating _ ratio( 1, 0 ) +
Ln_asset and D/A are proxied by the natural logarithm of book value of total assets and debt to asset ratio in the announcement year,
respectively. CG_index represents the corporate governance index and is an endogenous variable. Changes of independent variables are
computed as the differences between the announcement year and the year before. Changes of dependent variables are computed as the
differences between the year after and the announcement year. This table shows the result of the final stage of the 2SLS regression, so the
coefficients of instrumental variableFloating_ratio are not included. The absolute value of t statistics is in brackets. *, ** and ***
represent significance level at 10%, 5% and 1% respectively.
Variables

Sales

Profit

Unit

(Billion)

(Billion)

6.055

0.310

-0.001

-1.651

4.941

0.675

-0.009

[5.82]***

[2.69]***

[0.09]

[3.24]***

[5.22]***

[8.44]***

4.099

-0.119

-0.022

-3.735

3.979

[0.90]

[0.24]

[0.32]

[1.67]*

-12.426

-1.241

-0.062

[1.28]

[1.15]

[0.43]

Ln_asset
D/A
CG_index
Constant

Obersevations

ROA

ROS

Total Cost

Total Fee

(Billion)

(Billion)

COS

FOS

SOW

COW

ROW

(10000)

(10000)

(10000)

1.565

69.020

59.621

0.667

[0.80]

[3.49]***

[2.61]***

[2.56]**

[0.21]

0.016

-0.080

2.879

268.266

235.511

-15.218

[0.96]

[0.04]

[1.63]

[1.46]

[2.10]**

[2.09]**

[1.00]

0.035

-10.465

-0.745

0.160

1.141

85.712

33.642

28.065

[0.01]

[1.18]

[1.00]

[1.53]

[0.27]

[0.51]

[0.23]

[1.41]

-125.528

-6.385

0.017

36.698

-102.603

-13.737

0.240

-34.612

-1,513.810

-1,309.740

-7.545

[5.82]***

[2.67]***

[0.05]

[3.47]***

[5.23]***

[8.28]***

[1.03]

[3.72]***

[2.74]***

[2.69]***

[0.12]

545

545

545

544

545

545

544

544

467

467

467

22

Table 8: The Effect of Corporate Governance Index on the Market

Performance of Acquiring Firms-2SLS Regression
Tq70 and Tq80 are Tobinqs calculated by taking account of illiquidity discount of
70% and 80% in the Chinese listed companies, respectively. Ln_asset and D/A are
proxied by the natural logarithm of book value of total assets and debt to asset ratio,
respectively. CG_index represents the corporate governance index and is an
endogenous variable. CG_index_sqr is the square of CG_index. This table shows the
result of the final stage of the 2SLS regression, so the coefficients of instrumental
variableFloating_ratio are not included. The absolute value of t statistics is in
brackets. *, ** and *** represent significance level at 10%, 5% and 1% respectively.
Periods
Variables
Ln_asset
D/A
CG_index
CG_index_sqr
Constant

Obersevations

The year before

Tq70

Tq80

The announcement year

Tq70

Tq80

The year after

Tq70

Tq80

-0.660

-0.554

-0.750

-0.614

-0.487

-0.403

[14.00]***

[11.75]***

[12.07]***

[11.29]***

[12.45]***

[11.57]***

1.173

1.083

-0.133

-0.100

0.973

0.891

[10.20]***

[9.19]***

[0.50]

[0.39]

[9.82]***

[10.18]***

0.247

0.371

0.046

0.184

0.030

0.128

[2.56]**

[3.85]***

[0.37]

[1.69]*

[0.34]

[1.64]

-0.018

-0.028

-0.001

-0.019

0.011

0.021

[1.56]

[2.49]**

[0.06]

[1.37]

[0.55]

[1.14]

14.927

12.559

17.488

14.427

10.986

9.105

[15.29]***

[12.87]***

[13.95]***

[13.15]***

[13.16]***

[12.24]***

552

552

597

597

599

599

C. Earnings Management and the Performance of Acquiring Firms

We have argued that if M&As are driven by the agency or hubris motive, earnings
management by managers will be obvious and has significant effect on the short-term
operating performance. To test this hypothesis, we first measure the level of earnings
management. Given the definitions of four discretionary accruals, the value of each variable
for acquiring firms from 1999 to 2003 is calculated according to the CSMAR Financial
Statement Database. Table 9 shows the summary statistics for four discretionary accruals of
acquiring firms over the year of announcement, the year before and the year after. It suggests
the level of earnings management increases gradually after the acquisition. In the
announcement year, although DTAC and MDTAC are not significantly different from zero
(but marginally), MDCA and MDLA are both significantly different from zero. In the year
after acquisition, all these four variables are significantly different from zero. This proves
the action of earnings management by the managers of acquiring firms.
23

Table 9: Time-Series Discretionary Accruals Comparison of Acquiring Firms

DTAC is discretionary total accruals by Jones model, MDTAC is discretionary total
accruals by modified Jones model, MDCA is discretionary current accruals by
modified Jones model, and MDLA is discretionary long-term accruals by modified
Jones model. The numbers in the table are mean values. The absolute value of t
statistics is in brackets. *, ** and *** represent significance level at 10%, 5% and
1% respectively.
Variables
DTAC
MDTAC
MDCA
MDLA

The year before

The announcement year

The year after

(1)

(2)

(3)

0.000

0.005

0.010

[0.107]

[1.076]

[2.455]**

0.001

0.007

0.010

[0.208]

[1.330]

[2.544]**

-0.006

-0.016

-0.010

[0.885]

[1.877]*

[1.715]*

0.007

0.023

0.021

[1.123]

[2.911]***

[3.701]***

To further test the effect of earnings management on the operating performance of acquiring
firms, we regress the changes in eleven performance indicators on the changes in earnings
management variables respectively. Specifically, we apply the following OLS regression
model:

PER( 1, 0 ) = 0 + 1 Ln _ asset 0 + 2D / A0 + 3 DTAC ( 1, 0 ) +

(4)

Where (-1,0) denotes the changes of variables from the year before to the announcement
year. The regression results are reported in Table 10. It suggests that the coefficients of

DTAC are significantly positive when the dependent variables are Profit, ROA,
ROS and ROW, and significantly negative when the dependent variables are Total
Fee and COS. Moreover, when MDTAC is used in regressions instead of DTAC, the
results are almost identical. It is very clear that the change in earnings management level
significantly affects the change in the operating performance of acquiring firms, especially
on the aspects of improving profitability and lowering cost. To examine the method of
earnings management, we further divide discretionary accrualsMDTACinto discretionary
24

current accrualsMDCAand discretionary long-term accrualsMDLA. The regression

results in Table 11 suggest that the sign and significance of the coefficient of MDCA are
exactly same to the coefficient of DTAC in Table 10, and MDLA only has one
significant coefficient. Therefore, current accruals are easier to be manipulated than
long-term accruals, which is consistent with the result of Guenther (1994).

We also take account of the possibility that earnings management affects operating
performance gradually. Thus, we replace the change of operating performance from the year
before to the announcement year with that from the announcement year to the year after in
the equation (4), keeping other variables unchanged. This new regression will capture the
effect of the change of earnings management level on the lag change of operating
performance of acquiring firms. The results in Table 12 and 13 suggest that the coefficients
of earnings management variables turn to be insignificant for most of regressions. This
means that earnings management only has significant effect on the short-term operating
performance.

In addition, we test the relationship between earnings management and market performance
of acquiring firms. In general, there is a negative relationship between earnings management
and the firms market performance (Erickson and Wang, 1999). Similarly, we regress the
market performance on the earnings management variables cross-sectionally for a given year
in the estimation window, and compare the change of coefficient. From this, we can judge
the market reaction to the M&A event. Under the rational market expectations, the market
reaction to the M&As driven by the agency or hubris motive will be negative. Specifically,
we apply the following 2SLS regression model:

PERi = 0 + 1 Ln _ asseti + 2D / Ai + 3 DTACi + 4 DTAC _ sqri + i

(5)

Where PER is the variable for the market performance of acquiring firms measured by Tq70
and Tq80. Ln_asset, D/A, and DTAC are defined in the same manner with equation (4). We
also include the square of DTAC, denoted by DTAC_sqr, to take account of the possibility
25

that there may be a nonlinear relationship between earnings management and market
performance. The regression result is presented in Table 14. It suggests that in the year
before acquisition, earnings management has insignificantly negative effect on the market
performance. However, after the acquisition, this negative effect turns to be significant. This
result is consistent with the finding of Louis (2004), which means that the market expects
acquiring firms manipulate its earnings and discounts its stock price sharply. Therefore, the
market reaction to acquisitions is negative. Moreover, when MDTAC is used in regressions
instead of DTAC, the results are almost identical. We also note that the coefficients of
DTAC_sqr are significant for only two regressions, which means that the nonlinear
relationship between corporate governance and market performance is not stable.

Up to now, we have found evidences that earnings management of acquiring firms is

obvious, the change of earning management has significant effect on the change of
short-term operating performance. In addition, earnings management has significantly
negative effect on the market performance after the acquisition, which means the market
reaction to acquisitions is negative. Together with the fact that the long-term performance
decreases significantly, the hypothesis II is proved to be true. Therefore, mergers and
acquisitions in Chinese listed companies are mainly driven by the agency or hubris motive.
The M&As are just tools of managers to pursue their own interests at the expense of
shareholders or the means of controlling shareholders to expropriate minority shareholders.
Actually, these two types of agency problems are very popular in Chinese listed firms due to
the weak legal enforcement and corporate governance, for example, Bai, Liu and Song
(2004) find evidences of tunneling in Chinese listed companies. Obviously, M&As driven
by the agency or hubris motive are value decreasing transactions for acquiring firms. In
order to disguise the loss induced by M&As, the acquirers managers have strong incentives
of earnings management. However, they can effectively manipulate earnings only in the
short term, and the negative effect of agency or hubris problem is inevitably reflected in the
long-term performance.

26

Table 10: The Effect of the Change of Earnings Management on the Change of Operating Performance of Acquiring
Firms-OLS Regression
Ln_asset is a control variable proxied by the natural logarithm of book value of total assets. D/A is debt to asset ratio representing the firms
risk. DTAC is discretionary total accruals by Jones model. The Changes are computed as the differences of variables between the
announcement year and the year before. White-correct absolute value of t statistics is in brackets. *, ** and *** represent significance level
at 10%, 5% and 1% respectively.
Variables

Sales

Profit

Unit

(Billion)

(Billion)

2.037

0.052

0.021

0.202

1.671

0.310

[3.50]***

[0.73]

[0.78]

[1.47]

[3.12]***

[4.23]***

[0.82]

[0.32]

[1.97]*

[1.28]

[0.75]

3.784

0.573

0.111

-0.113

3.424

-0.016

0.309

-1.741

95.678

79.477

-4.477

[1.97]**

[1.13]

[1.03]

[0.09]

[1.93]*

[0.04]

[1.16]

[1.03]

[1.48]

[1.60]

[0.34]

-3.524

0.834

0.261

2.450

-3.621

-0.743

-0.214

-1.127

123.259

72.892

29.885

[1.25]

[2.03]**

[1.91]*

[2.03]**

[1.37]

[2.10]**

[1.87]*

[1.09]

[1.47]

[0.79]

[1.98]**

-43.678

-1.302

-0.495

-4.336

-36.008

-6.387

0.318

-0.277

-610.074

-545.915

56.975

[3.46]***

[0.91]

[0.87]

[1.67]*

[3.08]***

[4.19]***

[0.71]

[0.09]

[2.01]**

[1.30]

[0.80]

Observations

489

489

489

487

489

489

487

487

407

407

407

R-squared

0.08

0.03

0.09

0.05

0.07

0.07

0.08

0.05

0.02

0.02

0.02

Ln_asset
D/A
DTAC
Constant

ROA

ROS

Total Cost

Total Fee

(Billion)

(Billion)

COS

-0.022

FOS

0.056

SOW

COW

ROW

(10000)

(10000)

(10000)

28.288

25.300

-2.489

27

Table 11: The Effect of the Change of Earnings Management on the Change of Operating Performance of Acquiring
Firms-OLS Regression (Continued)
PER( 1, 0 ) = 0 + 1 Ln _ asset 0 + 2D / A0 + 3 MDCA( 1, 0 ) + 4 MDLA( 1, 0 ) +
Ln_asset is a control variable proxied by the natural logarithm of book value of total assets. D/A is debt to asset ratio representing the firms risk.
MDCA is discretionary current accruals by modified Jones model, and MDLA is discretionary long-term accruals by modified Jones model. The
Changes are computed as the differences of variables between the announcement year and the year before. White-correct absolute value of t
statistics is in brackets. *, ** and *** represent significance level at 10%, 5% and 1% respectively.
Variables

Sales

Profit

Unit

(Billion)

(Billion)

2.031

0.049

0.020

0.197

1.666

0.311

-0.02

[3.47]***

[0.70]

[0.77]

[1.48]

[3.08]***

[4.25]***

3.752

0.552

0.107

-0.149

3.405

[1.93]*

[1.14]

[1.04]

[0.12]

-2.777

0.918

0.269

[1.02]

[2.35]**

-2.696

Ln_asset
D/A
MDCA
MDLA
Constant

ROA

ROS

Total Cost

Total Fee

(Billion)

(Billion)

COS

FOS

SOW

COW

ROW

(10000)

(10000)

(10000)

0.047

28.614

25.498

-2.408

[0.86]

[0.29]

[1.99]**

[2.02]**

[0.72]

-0.01

0.318

-1.773

83.667

71.515

-6.808

[1.89]*

[0.02]

[1.27]

[1.08]

[1.29]

[1.25]

[0.49]

2.442

-2.996

-0.703

-0.251

-0.817

172.613

107.688

35.55

[1.99]**

[2.13]**

[1.17]

[2.14]**

[1.83]*

[0.75]

[2.14]**

[1.52]

[1.81]*

0.432

0.154

1.427

-2.834

-0.49

-0.003

-1.762

125.494

76.573

25.406

[1.30]

[1.07]

[1.22]

[1.36]

[1.48]

[1.51]

[0.03]

[2.16]**

[1.41]

[0.98]

[1.21]

-43.549

-1.222

-0.479

-4.212

-35.905

-6.407

0.277

-0.069

-610.711

-545.941

56.467

[3.42]***

[0.86]

[0.85]

[1.67]*

[3.04]***

[4.21]***

[0.71]

[0.02]

[2.02]**

[2.05]**

[0.79]

Observations

489

489

489

487

489

489

487

487

407

407

407

R-squared

0.07

0.05

0.11

0.06

0.07

0.07

0.14

0.07

0.03

0.02

0.03

28

Table 12: The Effect of the Change of Earnings Management on the Lag Change of Operating Performance of Acquiring
Firms-OLS Regression
PER( 0,1) = 0 + 1 Ln _ asset 0 + 2D / A0 + 3 DTAC ( 1, 0 ) +
Ln_asset is a control variable proxied by the natural logarithm of book value of total assets. D/A is debt to asset ratio representing the firms
risk. DTAC is discretionary total accruals by Jones model. Changes of independent variables are computed as the differences between the
announcement year and the year before. Changes of dependent variables are computed as the differences between the year after and the
announcement year. White-correct absolute value of t statistics is in brackets. *, ** and *** represent significance level at 10%, 5% and 1%
respectively.
Variables

Sales

Profit

Unit

(Billion)

(Billion)

5.485

-0.004

-0.005

-1.830

4.742

0.670

-0.001

[2.93]***

[0.03]

[0.30]

[0.97]

[2.63]***

[6.70]***

8.059

0.241

-0.015

-3.936

7.345

[1.37]

[0.45]

[0.21]

[1.02]

-12.635

0.014

0.126

[1.37]

[0.03]

-116.263

Total Fee

(Billion)

(Billion)

COW

ROW

(10000)

(10000)

(10000)

1.797

82.965

70.989

0.613

[0.10]

[1.04]

[1.34]

[1.29]

[0.19]

0.183

-0.103

2.868

239.475

223.527

-28.424

[1.28]

[0.35]

[1.62]

[0.80]

[1.34]

[1.30]

[1.96]*

-6.376

-11.960

-0.592

-0.065

6.201

-41.169

-87.130

39.141

[1.33]

[0.80]

[1.33]

[1.44]

[0.91]

[0.85]

[0.15]

[0.33]

[2.10]**

-0.091

0.083

40.639

-100.718

-13.730

0.100

-39.512

-1,784.40

-1,539.24

2.229

[2.83]***

[0.03]

[0.24]

[0.97]

[2.53]**

[6.59]***

[0.33]

[1.03]

[1.32]

[1.27]

[0.03]

Observations

485

485

485

484

485

485

484

484

411

411

411

R-squared

0.08

0.00

0.00

0.04

0.07

0.15

0.02

0.04

0.03

0.03

0.02

D/A
DTAC
Constant

ROS

Total Cost

SOW

Ln_asset

ROA

COS

FOS

29

Table 13: The Effect of the Change of Earnings Management on the Lag Change of Operating Performance of Acquiring
Firms-OLS Regression (Continued)
PER( 0,1) = 0 + 1 Ln _ asset 0 + 2D / A0 + 3 MDCA( 1, 0 ) + 4 MDLA( 1, 0 ) +
Ln_asset is a control variable proxied by the natural logarithm of book value of total assets. D/A is debt to asset ratio representing the firms risk.
MDCA is discretionary current accruals by modified Jones model, and MDLA is discretionary long-term accruals by modified Jones model.
Changes of independent variables are computed as the differences between the announcement year and the year before. Changes of dependent
variables are computed as the differences between the year after and the announcement year. White-correct absolute value of t statistics is in
brackets. *, ** and *** represent significance level at 10%, 5% and 1% respectively.
Variables

Sales

Profit

Unit

(Billion)

(Billion)

5.487

-0.008

-0.005

-1.836

4.747

0.672

-0.002

[2.92]***

[0.05]

[0.33]

[0.97]

[2.62]***

[6.74]***

8.089

0.218

-0.017

-3.885

7.394

[1.36]

[0.42]

[0.24]

[1.02]

-11.424

0.228

0.136

[1.27]

[0.46]

-8.639

-0.251

[1.39]

[0.50]

[0.45]

-116.361

0.004

0.096

[2.81]***

[0.00]

[0.27]

[0.98]

Observations

485

485

485

R-squared

0.08

0.01

0.01

Ln_asset
D/A
MDCA
MDLA
Constant

ROA

ROS

Total Cost

Total Fee

(Billion)

(Billion)

COS

FOS

SOW

COW

ROW

(10000)

(10000)

(10000)

1.791

82.942

70.803

0.718

[0.11]

[1.04]

[1.34]

[1.30]

[0.22]

0.195

-0.103

2.771

228.752

222.286

-32.700

[1.27]

[0.39]

[1.60]

[0.80]

[1.13]

[1.14]

[1.14]

-6.354

-11.016

-0.623

-0.061

6.484

19.320

-48.172

48.248

[1.50]

[0.80]

[1.26]

[1.59]

[0.85]

[0.89]

[0.07]

[0.18]

[2.16]**

0.045

-6.450

-8.094

-0.190

-0.064

4.925

-25.213

-48.317

29.076

[0.88]

[1.36]

[0.48]

[0.91]

[0.74]

[0.13]

[0.29]

[1.30]

40.759

-100.874

-13.79

0.102

-39.324

-1,778.34

-1,534.50

2.117

[2.52]**

[6.62]***

[0.33]

[1.03]

[1.32]

[1.27]

[0.03]

484

485

485

484

484

411

411

411

0.04

0.07

0.15

0.02

0.05

0.03

0.03

0.03

30

Table 14: The Effect of Earnings Management on the Market Performance

of Acquiring Firms-OLS Regression
Tq70 and Tq80 are Tobinqs calculated by taking account of illiquidity discount of
70% and 80% in the Chinese listed companies, respectively. Ln_asset and D/A are
proxied by the natural logarithm of book value of total assets and debt to asset ratio,
respectively. DTAC is discretionary total accruals by Jones model. DTAC_sqr is the
square of DTAC. White-correct absolute value of t statistics is in brackets. *, ** and
*** represent significance level at 10%, 5% and 1% respectively.
Periods
Variables
Ln_asset
D/A
DTAC

The year before

Tq70

Tq80

The announcement year

Tq70

Tq80

The year after

Tq70

Tq80

-0.763

-0.680

-0.798

-0.702

-0.493

-0.434

[17.33]***

[17.10]***

[16.59]***

[16.78]***

[15.43]***

[15.46]***

1.281

1.238

-0.152

0.049

0.944

0.909

[12.15]***

[13.00]***

[0.70]

[0.26]

[9.87]***

[10.81]***

-0.147

-0.165

-2.765

-2.326

-0.835

-0.735

[0.38]

[0.47]

[6.66]***

[6.44]***

[2.47]**

[2.48]**

0.346

0.210

3.201

2.685

0.704

0.669

[0.35]

[0.23]

[5.37]***

[5.18]***

[0.97]

[1.05]

17.032

15.108

18.468

16.165

11.158

9.796

[18.41]***

[18.08]***

[18.24]***

[18.36]***

[16.34]***

[16.32]***

Observations

491

491

578

578

612

612

R-squared

0.50

0.51

0.37

0.37

0.39

0.40

DTAC_sqr
Constant

V. Conclusions
This study researches the M&A motives and their effectiveness by analyzing the relationship
between corporate governance, earnings management and the performance of acquiring
firms. We make two hypotheses in this paper. Hypothesis I postulates that if M&As are
driven by the synergy motive, the long-term performance and corporate governance of
acquiring firms will be improved significantly, and corporate governance has significant
effect on the long-term operating performance of acquiring firms, and the market reaction
will be positive. Hypothesis II assumes if M&As are driven by the agency or hubris motive,
the long-term performance of acquiring firms will decrease significantly, and earnings
management by managers will be obvious and has significant effect on the short-term
operating performance, and the market reaction will be negative. Using a sample of 618
acquisitions in Chinese listed companies, we test these hypotheses. The empirical evidence
suggests that the long-term performance of acquiring firms decreases significantly.
31

Corporate governance of acquiring firms is not improved and has no significant effect on the
operating performance. However, earnings management is very obvious and has significant
effect on the short-term performance of acquiring firms. Furthermore, the market reaction to
acquisitions is negative. Therefore, M&As in Chinese listed companies are mainly driven by
agency or hubris motive, and the synergy effect is not realized basically.

The contributions of this study lie in three aspects. First, this paper provides a new way to
identify and analyze the motives of acquiring firms, especially from the perspectives of
corporate governance and earnings management. Second, we measure the performance of
acquiring firms more comprehensively than the former studies. Thirteen indicators
employed in this study not only include profitability, but also comprise of production, cost
and productivity and market performance. This makes our results more robust. Finally, we
not only find the evidence of earnings management of acquiring firms, but also identify the
possible method of earnings management. In sum, our findings make an important
contribution towards a better understanding of the mechanisms behind the current massive
acquisitions in China. The main finding that acquisitions are mainly driven by the agency or
hubris motive suggests that corporate governance structure in Chinese listed companies is
far from effective and well developed. The corporate governance of Chinese listed
companies needs to be improved and M&As need to be instructed and regulated. Therefore,
this paper has important implications for listed firms and regulatory authorities in China.

Appendix: Calculation of Discretionary Accruals

In accounting, accruals are measured as follows:

TAC=Net Income-Cash Flow form Operations

(6)

Where TAC denotes total accruals. As stated in Xia (2003), excluding extraordinary items
and discontinued operations form net income will enhance the models power in detecting
discretionary accruals in China. So, we use operating income instead of net income to
compute total accruals.
32

TAC=Operating Income-Cash Flow form Operations

(7)

Total accruals can be classified into discretionary accruals and non-discretionary accruals
based on whether they are necessary adjusting or simply a result of management discretion.
We use the cross-sectional adaptation of the Jones (1991) model in derivation of
discretionary accruals and non-discretionary accruals. The model applies cross-sectional
regression on accruals of firms in the same industry to obtain predicted values as
non-discretionary accruals. Specifically, the regression model is as follows:

TAC jt
TA j ,t 1

1
SALES jt
+ b1
= b0
TA
TA
j ,t 1
j ,t 1

PPE jt

+ b2
+ jt
TA

j ,t 1

(8)

Where TACjt is total accruals of firm j in year t; SALESjt is calculated as SALESjt

SALESj,t-1, or changes in sales revenue; PPEjt is gross property, plant and equipment for firm
j in year t; TAj,t-1, total assets in year t-1, is used as denominator to reduce heteroskedasticity.
To obtain non-discretionary accruals for firm j, the data of all firms in the same industry
except firm j are used in the regression. Here we use the industrial classification criterion
developed by China Securities Regulatory Commission (CSRC)10. The non-discretionary
accruals, NDTACjt, is computed as

1
SALES jt
+ b1
NDTAC jt = b0
TA
TA
j ,t 1
j ,t 1

PPE jt

+ b2

TA

j ,t 1

(9)

Discretionary accruals, DTACjt, is calculated as the difference between total accruals and
non-discretionary accruals.

10

It divides all listed companies into thirteen main industries and subdivides every main industry into several subindustries.
Due to the clustering of firms in the manufacturing industry (denoted by Code C), we treat ten subindustries of C as main
industries.
33

DTAC jt =

TAC jt
TA j ,t 1

NDTAC jt

(10)

The modified Jones model employs the same regression model with Jones model. The only
difference is that it subtracts the increase in accounts receivable from sales growth when
estimating non-discretionary accruals. This treatment allows for the possibility of credit sales
manipulation by the firm (Dechow, Sloan and Sweeney, 1995). Here the non-discretionary
accruals by modified Jones model, MNDTACjt, is calculated as

1
SALES jt AR jt
+ b1
MNDTAC jt = b0
TA

TA j ,t 1
j ,t 1

PPE jt
+ b2

TA

j ,t 1

(11)

Where ARjt is the change in accounts receivable for firm j in year t relative to year t-1, and
b0 , b1 and b2 are estimated form equation (6). Therefore, the discretionary accruals by

modified Jones model, MDTACjt, is calculated as

MDTAC jt =

TAC jt
TA j ,t 1

MNDTAC jt

(12)

We further divide the discretionary accruals into the discretionary current accruals and the
discretionary long-term accruals according to Teoh et al. (1998). They point that accruals can
be classified into current accruals and long-term accruals based on the time period and
managerial control. Following Teoh et al. (1998), current accruals (CA) are the change in
noncash assets minus the change in operating current liabilities:

CA=[current assetscash][current liabilitiescurrent maturity of long-term debt] (13)

To obtain the discretionary current accruals, we first perform the intra-industry regression of
current accruals on the change in sales that is similar to equation (6).
34

CA jt
TA j ,t 1

1
SALES jt
+ b1
= b0
TA
TA
j ,t 1
j ,t 1

+ jt

(14)

As in Teoh et al. (1998), the following indicators of accruals are calculated by the modified
Jones model. The non-discretionary current accruals, MNDCAjt, is computed as

1
SALES jt AR jt
+ b1
MNDCA jt = b0
TA

TA j ,t 1
j ,t 1

(15)

Discretionary current accruals, MDCAjt, is calculated as the difference between current

accruals and non-discretionary current accruals. And discretionary long-term accruals,
MDLAjt, equals discretionary total accruals (MDTACjt) minus discretionary current accruals

(MDCAjt).

MDCA jt =

CA jt
TA j ,t 1

MNDCA jt

MDLA jt = MDTAC jt MDCA jt

(16)
(17)

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37