Do managers manipulate earnings prior to management buyouts?

To address the question as to whether managers intending to purchase their company by means of a levered buyout transaction manipulate earnings in order to buy their firm on the cheap, we study the different types of earnings management prior to the transaction: accrual management, real earnings management, and asset reserves revaluation. To identify the management engagement incentives, we contrast earnings management in management buyouts (MBOs) with that in (i) institutional buyouts (IBOs) and (ii) non-buyout firms. We find: (i) strong negative earnings management via both accrual and real earnings activities in MBOs supporting the above management engagement incentive, (ii) modest negative accrual management and insignificant real earnings manipulation in IBOs, and (iii) positive earnings management in non-buyout firms. Asset revaluation in MBOs is not a frequently used channel. We do not find evidence that a high external borrowing need in the levered transactions mitigates the downward earnings manipulation in MBOs. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real earnings management in MBOs, but increased the relative use of real earnings management as this may be harder to detect.