Historical perspectives on accounting for M&A

Abstract

This paper attempts to tease out some of the reasons why the history of M&A accounting has been so fraught. It compares the different M&A accounting regimes which have been tried over time in UK, US and international standards. It illustrates the quantitative impact of alternative accounting regimes on financial statements. It asks whether the resulting numbers make any difference to decisions and behaviour. It charts the rising scale of M&A expenditures which have accompanied the different accounting regimes. And it suggests that a number of historical developments have intensified the challenges posed by accounting for M&A – developments in firms’ investment choice between M&A or new tangibles, in the role of intangibles, in means of payment for M&A, in stock market price movements, in the synergies created by M&A, and in ‘creative accounting’.

Keywords:

• M&A accounting
• intangibles
• M&A financing
• creative accounting

JEL Classification:

• G24
• K22
• L25
• M41
• M48

Acknowledgements

We thank the editors of Accounting and Business Research and an anonymous referee for helpful comments. We are very grateful for help in preparing this paper to Jonathan Faasse, Brian Singleton-Green, Geoffrey Whittington, Ken Wild, Steve Zeff, and participants in the 2015 ICAEW Information for Better Markets Conference.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. The terms merger, acquisition, and takeover are used interchangeably in the paper to refer to any business combination. To reduce confusion, ‘pooling’ and ‘purchase’ are reserved for the techniques of accounting for combinations which have sometimes been described as ‘merger’ and ‘acquisition’.

2. Zeff (1972) provides a vivid blow by blow account of the struggles preceding the 1970 compromise Opinions.

3. Encouraged – SSAP22; allowed – AICPA (1970a,b); forbidden – SFAS141, IFRS3. See below.

4. Required – FRS10 (with rarely used exception); allowed – AICPA (1970a,b)(as an option to pooling); forbidden – SFAS141, IFRS3. See below.

5. It is simpler to discuss the valuation of a listed target, where market prices are published; but the same framework applies to unlisted targets. Prices of target shares tend to rise in the weeks ahead of a bid (Jarrell and Poulsen 1987, Schwert 1996), presumably because of insider trading or rumours about a pending offer: in this framework that price rise is incorporated in PREMIUM.

6. Distinct from the more common notion of ‘premium’ in the share premium account – the excess over par value when new shares are issued.

7. For example, economies of scale; but also, in this context, private gains to the firms which are associated with social costs to society, such as tax inversion schemes to avoid tax, or horizontal mergers to eliminate competitors – with associated disadvantages to customers. The managers’ synergy estimates are not routinely disclosed, though earnings forecasts are sometimes volunteered (Amel-Zadeh and Meeks 2016).

8. The two can be equivalent, for example, if the acquirer pays with its own shares, if payment equals the target’s market value, and if market/book is the same for acquirer and target.

9. Strictly speaking purchased goodwill is the discrepancy between MARKET and fair value-adjusted BOOK plus PREMIUM, but we abstract from fair value adjustments for ease of exposition. We have found in our empirical work that, on average, fair value adjustments on takeover have been surprisingly small.

10. We are not exploring the concept of goodwill in this paper, on which much has been written. Johnson and Petrone (1998) provide a helpful analysis.

11. See, for example, Bloomberg, ‘HP Plunges on $8.8 Billion Charge From Autonomy Writedown’, November 20, 2012 (available at http://www.bloomberg.com/news/articles/2012-11-20/hewlett-packard-profit-forecast-8-8-billion-charge) [Accessed 25 May 2016].

12. Non-financial, with financial years ending in December.

13. On the introduction of IFRS some firms netted off the amortisation account against goodwill, while others continued to report gross cost and amortisation/impairment accounts. The data before and after IFRS cannot therefore be compared directly.

14. Amel-Zadeh et al. (2015) find that share prices are actually correlated (negatively) with cumulative amortisation, but interpret this as market values following the anticipated reduction in the value of goodwill: cumulative amortisation is not revealing fresh information, but it does secure disclosures which ‘better reflect the economics of [those] assets’ – an objective voiced by FASB (2001c, p. 7).

15. Ironically, when offered the option in practice of amortisation or impairment-only, after the 1998 regime change with FRS 10, 97% actually elected to adopt amortisation (Amel-Zadeh et al. 2015).

16. One of the most lucid explanations of the challenges of purchased goodwill in the literature. Interestingly, most of it is just as relevant now as when it was written a quarter century ago.

17. Note Singleton-Green’s cautionary discussion (ICAEW 2015, esp. pp. 17, 23) of the difficulties of inferring value-relevance causation from correlations between accounting numbers and share prices. There may be reverse causation, as in the case we discuss here: a fall in share price triggers an impairment. Or share prices may correlate with a change in an accounting number even though that number brings no new information to the stock market – a case discussed in footnote 14 above in relation to cumulative amortization.

18. See Meeks and Meeks (2002), Meeks and Swann (2009) and Schipper (2010) on cost-benefit considerations.

19. The changes of the 1990s were presaged by the influential papers of Stacy and Tweedie (1989) and Tweedie and Whittington (1990), which identified accounting for M&A as one of the four core problems of financial reporting at that time. As a result of the 1994 amendments, the number of deals qualifying for pooling fell drastically (Wilson et al. 2001).

20. This pattern of diversification by M&A across national boundaries echoes the earlier patterns of diversification by M&A across industry boundaries (see Goudie and Meeks 1982).

21. More recently the share has rarely fallen below 30% (Hammond and Massoudi 2014).

22. The UK also re-confirmed the continuing requirements for goodwill amortization for all UK companies not subject to IFRS with the introduction of FRS102 with effect from January 2015, albeit with a much shorter amortization period of a maximum of 5 years.

23. Because of this difficulty – of separating intangibles from the organisation in which they are embedded – it seems likely that bidders will be especially interested in targets which are rich in intangibles: they cannot be acquired without M&A as easily as tangibles. So not only is M&A increasing, and the share of corporate assets represented by intangibles rising, but also companies rich in intangibles are likely to be disproportionately represented among M&A targets. We are grateful to Geoffrey Whittington for pointing this out.

24. For empirical analysis of the theory see, for example, Dong et al. (2006) and Gregory and Bi (2011).

25. For notorious specific examples, see Smith’s (1992) discussion of the UK company Coloroll, and Feder and Schiesel’s (2002) discussion of WorldCom.

26. For discussion of such difficulties with accounts see, for example, Meeks and Meeks (1981), Caves (1989), and Amel-Zadeh (2009).

27. Representative conclusions include (linked to sources in text via initials): ‘the estimated annual efficiency losses [attributed to US mergers] are in the range of 0.59 to 0.81 percent of current-dollar gross national product’ (RS); ‘Much of the evidence reviewed above [19 studies] indicates that many mergers generate neither efficiency gains nor market power’ (M); ‘the average abnormal return for up to two years post-acquisition is unambiguously and significantly negative’ (G); UK ‘acquisitions have [on average] a detrimental impact on company performance’ (DGT); US ‘acquiring firm shareholders lost 12 cents at the announcement of acquisitions for every dollar spent … from 1998 through 2001, whereas they lost … in all of the 1980s 1.6 cents per dollar spent … the losses of bidders exceed the gains of targets from 1998 through 2001 … ’ (MSS);US ‘acquisitions worsen, on average, the post-acquisition returns of the firms’ (GL). For neutral or more optimistic conclusions, see Franks and Harris (1989), Healy et al. (1992), Chatterjee and Meeks (1996), Higson and Elliott (1998) and Jensen (2010). Beginning in the late 1990s a valuable branch of the literature developed which aims to identify the types of acquisition which are more likely to fail – e.g. Healy et al. (1997), Rau and Vermaelen (1998), Capron (1999), Capron and Pistre (2002), Gregory (2005). Individual cases often referred to in the press of disappointed pre-merger expectations include Daimler/Chrysler, AOL/Time Warner, Invensys/Baan, HSBC/Household, RBS/ABN-AMRO, Morrison/Safeway, HP/Autonomy. On the AOL/Time Warner deal see Healy (2016) in this issue of Accounting and Business Research.

28. Following the takeover of Mannesmann by Vodafone, Mannesmann’s CEO and five directors were taken to court by shareholders, accused of having received excessive payouts by Vodafone to give up resistance to the deal (The Guardian, ‘Gent defends multi-million euro bonuses’, Friday 26 March 2004, available on http://www.theguardian.com/business/2004/mar/26/executivesalaries.executivepay1) [Accessed 25 May 2016]. All were subsequently acquitted of any wrong doing.

29. The difficulty of generalising about the impact of M&A on performance is illustrated by comparing this result for an RBS acquisition headed by Sir Fred Goodwin with the earlier takeover by RBS under Goodwin of NatWest, which was followed by a sharp rise in earnings per share and a two-year share price gain of over 100%.

30. It is outside the remit of this paper to offer a prescription for future M&A accounting – the topic of a companion paper in this issue by Healy (2016). Amel-Zadeh et al. (2015) outline the authors’ suggestions, based on the UK experience in 1998–2004.