Accounting choice, announcement returns and operating performance in stock-for-stock mergers

This study investigates the link between accounting choice and value creation in stock-for-stock mergers. Prior studies find stock acquirers have inferior announcement returns and poor post-merger performance compared with cash acquirers. Many stock takeover bids are made conditional on getting the pooling-of-interests ("pooling") accounting treatment that boosts the reported earnings. Pooling acquirers pay a significant premium on average for the desired accounting treatment.; If earnings rather than discounted net cash flows drive the merger decision, then pooling firms are more likely than purchase firms to make ex ante suboptimal investments. The fact that such transactions are approved by the board of directors and shareholders suggests potentially weak corporate governance in pooling firms.; In a sample of 390 stock-for-stock transactions over 1993--1999, I find proxies for functional fixation and income maximization are positively associated with pooling. I also find evidence consistent with pooling acquirers having relatively weak corporate governance. The cumulative abnormal returns around pooling merger announcements are lower compared with purchase announcements after controlling for overpayment, firm size, growth opportunities and industry membership. I also find a negative association between post-merger revenue growth, though not operating cash flows, and pooling after controlling for the step-up in assets, firm size, growth opportunities, past operating performance and industry.; On the whole, the evidence suggests the previously documented inferior announcement returns and post-merger performance of stock acquirers are largely contributed by pooling and not purchase firms. The study also presents evidence consistent with functional fixation and weak corporate governance in pooling firms.; These findings have several implications in light of the recent abolition of pooling and changes in the treatment of goodwill. For example, now that only purchase mergers are allowed regardless of the method of payment, will the previously documented differences between cash and stock acquirers decrease? The new rules on goodwill allocation and impairment testing can also have a bearing on transaction characteristics such as acquisition premium and post-merger performance.