On Quality of Earnings in SPAC Transactions

A proliferation of firms going public using a special purpose acquisition company (SPAC targets) during the pandemic sparked proposals to align financial disclosure requirements for SPAC transactions with the established IPO route. Our paper seeks to inform the debate by contrasting earnings quality of SPAC targets with IPOs. Examining a hand-collected dataset on SPAC mergers proposed between 2004 and 2019, we draw mixed findings on how propensity for earnings management compares with IPOs. Controlling for self-selection, we find the average SPAC exhibits significantly more accrual-based earnings management (AEM) and to a lesser degree real earnings management (REM) using discretionary expenses, but lower incidence of sales-based REM and classification shifting, compared to the typical IPO. With the exception of discretionary expense-based REM, earnings management correlates with significantly worse short-term de-SPAC returns. Moreover, incidence of sales-based REM and classification shifting typically reduces the prospect of successful deal completion, offering further explanation for observed substitution effects. Overall, the risk of earnings management in SPACs appears less severe than previously thought, characterised mostly by a shift to AEM from more destructive methods. We discuss implications for regulatory actions concerning SPAC disclosures.