How comparable are the financial statements of M&A bidders and acquirers in the same industry? And does financial statement comparability affect the outcome of a deal? In a recent paper, available here, we investigate these questions, using a sample of deals between U.S.-listed firms over the 1987-2021 period.
An accounting system maps economic transactions onto financial statements (Yip and Young, 2012). Accounting comparability reflects the tendency of two firms that have comparable accounting systems to produce similar (or dissimilar) financial statements for a given set of similar (or dissimilar) economic events (De Franco et al., 2011; Barth et al., 2012; Yip and Young, 2012; Choi et al., 2019).
Past research has associated financial statement comparability with (a) lower costs of acquiring information (De Franco et al., 2011; Chen et al., 2018; Choi et al., 2019) and (b) greater transparency and mitigation of information asymmetry between managers and capital providers (Cheng and Wu, 2018).
Only one significant study looks at the connection between accounting comparability and M&A. Chen et al. (2018) find that greater similarity between a target firm’s accounting and the accounting of its industry peers is positively associated with higher abnormal returns for the acquirer’s stock, and the combined acquirer and target stock, around deal announcement, and also with longer-term success of the combined company. They attribute this result to less uncertainty, as the acquirer can more easily predict the future cash flow of a combined company, more cheaply acquire information, and more efficiently value a target when the accounting of the target and its peers is closely comparable.
Motivated by that study, we investigate whether accounting comparability between the acquirer and the target, rather than between the target and its industry peers, is associated with more successful deals. Using a sample of 648 deals between U.S.exchange-listed firms in the same industry during 1987-2021, we find that higher levels of accounting comparability between the acquirer and the target are negatively associated with the stock market reaction around the deal announcement day (abnormal bidder and combined bidder-target abnormal stock returns are estimated using the market model for the window of [-1, +1] days relative to the announcement day (day 0)).
This finding is consistent with our hypothesis that, when the target and the acquirer use similar accounting methods, the acquisition should be less risky. This is because if similar economic events are accounted for and reflected in financial results in similar ways for a bidder and a target, there should be more certainty about how their underlying finances reflected on financial statements.
The second stage of our investigation examines the long-term performance of deals, based on target-and-acquirer comparability. We use the acquirer’s buy-and-hold abnormal return (based on Barber and Lyon, 1997) for a number of years following the date of deal announcement and the incidence of divestments following the deal completion.
We find that greater comparability between acquirers and targets is positively associated with acquirers’ buy-and-hold abnormal returns for the next one, two, and even three years. This finding is consistent with our hypothesis that, in deals involving comparable targets and acquirers, there should be fewer unpleasant surprises thanks to the greater similarity in the way firms’ finances and transactions are accounted for. To the extent that accounting comparability correlates with similarities in how the underlying finances of the two firms are reflected in their financial statements, we expect (and find) that greater accounting similarity between acquirers and targets should imply a lower possibility for any adverse economic results emerging later for either transaction party. This is also confirmed by our finding that more comparable targets and acquirers in deals within the same industry have fewer divestments after the deals. Taken together, these findings suggest that the greater the similarity between parties to a deal, the more successful the deal.
Our findings on the long-term performance of such deals are less pronounced when the acquirer (a) operates in more business segments, and (b) is less creditworthy, and more pronounced when the acquirer has less anti-takeover protection (measured by the E-score developed by Bebchuck et al. 2009). These findings indicate that the positive effect of acquirer-target comparability on longer-term market performance is weaker when business factors surrounding the deal are also weaker i.e. when the acquirer is more operationally complex because it operates in multiple business segments (Duchin et al., 2010), and so allocates capital less efficiently (Stein, 1997), and also has a higher risk of bankruptcy. By contrast, this result is stronger when market discipline is also stronger, because there are fewer anti-takeover provisions to insulate the acquirer from market pressure.
Therefore, mergers between companies that are more comparable, from a financial-reporting perspective, and whose acquirers are also stronger (weaker) performers, should result in even better (worse) outcomes.
Overall, our study contributes to research about the factors that determine the value and success of mergers and acquisitions and also to research about accounting comparability, by showing how comparative accounting information between acquirers and targets improves deal outcomes.
Barber, B. M. and Lyon, J. D., 1997. Detecting long-run abnormal stock returns: The empirical power and specification of test statistics. Journal of Financial Economics, 43(3), 341-372.
Barth, M.E., Landsman, W., Lang, M., and Williams, C., 2012. Are IFRS-based and US GAAP-based accounting amounts comparable? Journal of Accounting and Economics, 54(1), 68-93.
Bebchuk, L. A., Cohen, A., and Ferrell, A., 2009. What matters in corporate governance? Review of Financial Studies, 22(2), 783-827.
Cheng. J.-C., and Wu, R.-S., 2018. Internal capital market efficiency and the diversification discount: The role of financial statement comparability. Journal of Business Finance and Accounting, 45(5-6), 572-603.
Choi, J., Choi, S., Myers, L.A., and Ziebart. D.A., 2019. Financial statement comparability and the informativeness of stock prices about future earnings. Contemporary Accounting Research, 36(1), 389-417.
De Franco, G., Kothari, S. P., and Verdi, R., 2011. The beneﬁts of ﬁnancial statement comparability. Journal of Accounting Research, 49 (4), 895-931.
Duchin, R., Matsusaka, J.G., and Ozbas, O., 2010. When are outside directors effective? Journal of Financial Economics, 96(2), 195-214.
Stein, J.C., 1997. Internal capital markets and the competition for corporate resources. Journal of Finance, 52(1), 111–133.
Yip, R.W.Y, and Young, D., 2012. Does mandatory IFRS adoption improve information comparability? The Accounting Review, 87(5), 1767-1789.
This post comes to us from professors Seraina C. Anagnostopoulou at the University of Piraeus and Andrianos E. Tsekrekos at the Athens University of Economics and Business. It is based on their recent article, “Accounting Comparability between M&A Bidders and Targets and Deal Outcome,” available here.