Shared Auditors in Mergers and Acquisitions Lubomir Litov University of Arizona & Wharton Financial Institutions Centre, Univ. of Pennsylvania

Research Question and Motivation What is the role of (shared) auditors in acquisitions? Information is extremely important in acquisitions, as acquirers value targets’ assets/liabilities Auditors, who produce and certify information about their clients, seem particularly well- suited to provide information about targets

What We Do We examine the impact of shared auditors on deal outcomes and the probability of receiving a bid – Auditors are privy to confidential information, management discussions, and likely have expertise about the target firm – We expect shared auditors can provide information about clients to other clients (targets and acquirers) and serve as “information intermediaries”

Can Auditors Share Client Information? In 1989, Ernst & Whinney merged with Arthur Young – Coca-Cola was a client of E&W since the 1920’s – PepsiCo was a client of Arthur Young since 1960’s – A Coke executive disputed Pepsi’s account with the merged auditor, forcing Ernst & Young to drop PepsiCo

Hypotheses on Deal Outcomes Primarily, we predict shared auditors provide an informational advantage to acquirers – Superior information about target – Incentives: the acquirer survives and pays fees – Consistent accounting standards/practices In general, we expect shared auditors reduce information uncertainty and, hence, the costs of gathering information about targets Shared auditors facilitate bids

Specific Predictions on Deal Outcomes We expect the informational advantage increases the likelihood that an acquirer makes a bid for a target – Less fear of over-bidding With an information advantage relative to other bidders, bidders with shared auditors have a stronger position in negotiations – Lower premiums – Higher ACARs, Lower TCARs – Higher completion rates

Previous Literature and Contribution Advisers in M&A – Financial Advisers: McLaughlin (1992); Kale, Kini, Ryan (2003); Servaes and Zenner (1996) – Legal Advisers: Krishnan and Masulis (2013) Auditors in M&A – Golubov et al. (2011) Louis (2005); Neimi, Ojala, and Seppala (2008); Xie, Yi, and Zhang (2010) Focus is on Big-N vs. Non-Big-N

Previous Literature and Contribution Shared Agents in M&A – Shared financial advisers: Agrawal et al. (2011) – Shared directors: Cai and Sevilir (2012); Stuart and Yim (2010) Information in M&A – Form of payment and competition: Fishman (1989) – Negotiations: Povel and Singh (2006) – Contractual Provisions: Bates and Lemmon (2003)

Data CRSP/Compustat SDC – bids between 1985 and 2010 – Deals above $10 million – 3,598 bids For bid data, we create an indicator, shared auditors, equal to one if target and acquirer retain the same audit firm, as recorded by Compustat – Compustat data is lagged one year

Univariate Analysis Shared vs. Non-shared Auditors About 26% of sample bids have shared auditors Non-Shared AuditorShared Auditor VariableObsMeanObsMeanDifft-stat Premium2, *** Acquirer CAR2, Target CAR2, *** Completed2, *** Value of Transaction2, Tender Offer2, *** Cash Only Deal2, *** Hostile2, Number of Bidders2, *** Same 2-digit SIC2, ***

Univariate Analysis Shared vs. Non-shared Auditors About 26% of sample bids have shared auditors Non-Shared AuditorShared Auditor VariableObsMeanObsMeanDifft-stat Premium2, *** Acquirer CAR2, Target CAR2, *** Completed2, *** Value of Transaction2, Tender Offer2, *** Cash Only Deal2, *** Hostile2, Number of Bidders2, *** Same 2-digit SIC2, ***

Univariate Analysis Shared vs. Non-shared Auditors About 26% of sample bids have shared auditors Non-Shared AuditorShared Auditor VariableObsMeanObsMeanDifft-stat Premium2, *** Acquirer CAR2, Target CAR2, *** Completed2, *** Value of Transaction2, Tender Offer2, *** Cash Only Deal2, *** Hostile2, Number of Bidders2, *** Same 2-digit SIC2, ***

Univariate Analysis Do shared auditors facilitate bidding? Big-N Regime (Big-N only) Random Assignment Probability Percentage of Deals with a Shared AuditorDifference (Big-8) (N=19,715)(N=390) (Big-6) (N=57,181)(N=1,041) (Big-5) (N=39,053)(N=1,007) (Big-4) (N=47,140)(N=683) Average0.07

The Probability of Receiving a Bid Marginal Effects of Logistic Regressions VariableAll Big N Pre-SOXPost-SOX Auditor Industry Network0.041***0.030**0.065*** (4.50)(2.55)(5.14) Auditor Network0.068***0.063**0.026* (4.50)(2.53)(1.65) Target ControlsYes Industry ControlsYes Year ControlsYes N97,561 89,729 60,67436,887 Pseudo R The dependent variable equals one if a Compustat firm receives a bid

Shared Auditors and Deal Premiums (SDC Bid Data) Dependent Variable = Deal Premium All Deals Big N Deals Shared Auditor ** *** (-2.53)(-2.85) Shared Auditor Office ** ** (-2.26)(-2.54) Target/Acquirer/Deal Controls Yes Industry ControlsYes Year ControlsYes N3,3322,6512,9232,272 R Adj. R

Shared Auditors and Target Announcement Returns (SDC Bid Data) Dependent Variable = Target CAR (-1,1) All Deals Big N Deals Shared Auditor * * (-1.66)(-1.75) Shared Auditor Office *** *** (-3.96)(-3.50) Target/Acquirer/Deal Controls Yes Industry ControlsYes Year ControlsYes N2,8782,2792,5111,943 R Adj. R

Shared Auditors and Acquirer Announcement Returns (SDC Bid Data) Dependent Variable = Acquirer CAR (-1,1) All Deals Big N Deals Shared Auditor0.007 ** * (2.06)(1.82) Shared Auditor Office (0.60)(0.39) Target/Acquirer/Deal Controls Yes Industry ControlsYes Year ControlsYes N 2,9872,3572,6082,010 R Adj. R

Shared Auditors and Bid Completion (SDC Bid Data) Dependent Variable = Deal Completion Indicator All Deals Big N Deals Shared Auditor0.042 *** *** (3.43)(2.73) Shared Auditor Office0.101 *** *** (6.13)(4.50) Target/Acquirer/Deal Controls Yes Industry ControlsYes Year ControlsYes N3,5982,8663,1212,428 Pseudo R

Controlling For Selection Bias Premium Target CAR Acquirer CAR Completed Shared Auditor ** * *** (-2.48)(-1.37)(1.89)(2.58) Shared Auditor Office ** *** ** (-2.57)(-3.89)(-0.89)(2.51) Inverse Mills Ratio *** *** ** (3.14)(3.39)(1.59)(1.28)(-2.04)(-1.52) Target/Acquirer/Deal Controls Yes Industry Controls Yes Year Controls Yes N2,8032,2142,5411,9982,6052,0383,248 R Adj. R Rho LR Test Chi2 (p-value)

Premiums, Shared Auditors, and SOX Dependent Variable = Deal Premium All Deals Big N Deals Shared Auditor * Pre-SOX * ** (-1.91)(-2.08) Shared Auditor * Post-SOX (-1.10)(-1.49) Shared Auditor Office * Pre-SOX * ** (-1.72)(-2.01) Shared Auditor Office * Post-SOX * ** (-1.84)(-2.24) Deal ControlsYes Industry ControlsYes N 3,3322,6512,9232,272 R Adj. R

Completion, Shared Auditors, and SOX Dependent Variable = Indicator for Deal Completion All Deals Big N Deals Same Auditor Parent X Pre-SOX0.043 *** ** (3.11)(2.30) Same Auditor Parent X Post-SOX (0.34)(0.02) Same Auditor Local Office X Pre-SOX0.099 *** *** (5.27)(4.13) Same Auditor Local Office X Post-SOX0.091 *** (2.62)(0.95) Deal ControlsYes Industry ControlsYes N3,5982,8663,1212,428 Pseudo R