Acquirer Internal Control Weaknesses in the Market for Corporate Control

This paper examines how disclosures about internal controls, required by Sections 302 and 404 of the Sarbanes-Oxley Act of 2002 (SOX), affect the market for corporate control. We hypothesize that acquirers with internal control weaknesses (ICWs) make suboptimal acquisition decisions based on poor quality information generated by their ineffective controls over financial reporting. They likely overestimate the value of their targets or the potential synergies from mergers. Using a treatment sample of acquisitions made by acquirers that have disclosed ICWs and two-matched control samples without ICW disclosures, we document that ICW acquirers pay larger premiums and earn smaller cumulative abnormal returns around the announcement dates. We estimate that an ICW acquirer on average pays $46.6 million, or 6 percent more, in premium than a non-ICW acquirer. The future performance of ICW acquirers is also lower than that of non-ICW acquirers. Overall, our results suggest that ineffective internal controls hinder decision-making related to M&A and that investors appear to understand this effect.