Does ESG performance mitigate earnings management? Evidence from UK takeover targets

Abstract

Type of the article: Research ArticleAbstractThis study examines whether environmental, social, and governance (ESG) performance mitigates earnings management within the setting of corporate takeovers in the United Kingdom. The study utilized a panel dataset of 380 UK takeover targets (1,121 firm-year observations) acquired from 2013 to 2023. We measure accrual-based earnings management using discretionary accruals. The findings reveal that targets manipulate their earnings in the first year with an earnings release prior to the acquisition relative to other periods in the three-year event period under study (β = 0.0168, p < 0.10). Crucially, firms with higher aggregate ESG scores exhibit substantially lower discretionary accruals (β = –0.026, p < 0.05), indicating that strong ESG performance constrains opportunistic reporting. This mitigating effect is driven primarily by the social pillar of ESG (β = –0.00069, p < 0.01). These results indicate that earnings management by takeover targets is concentrated in the period of greatest valuation scrutiny, highlighting the strategic nature of preacquisition reporting behavior. Moreover, our results further suggest that ESG performance, particularly social responsibility, acts as a governance mechanism that constrains managerial opportunism when incentives to manipulate earnings are strongest.AcknowledgmentWe would like to thank the United Arab Emirates University for funding this research with the research grant number CARP Grant 2023.