Do Firms Adjust Their Acquisition Strategies and Payment Options in Response to Changes in Financial Reporting Incentives?

Abstract

This paper focuses on U.S firms’ acquisition strategy and payment options in response to changes in financial reporting requirements. We study the impact of Statement of Financial Accounting Standards (SFAS) 141, the accounting treatment of business combination, and its subsequent revision, SFAS 141(R), on firms’ participation in M&A activities and choice of payment methods. SFAS 141 eliminated the pooling interest method of accounting. The Financial Accounting Standards Board (FASB) revised the standards in 2007, with the SFAS 141(R), in an attempt to enhance the ability of financial reports to reflect firms’ financial situation. The revision strengthens the rules of accounting for contingent liabilities by requiring the fair value of earnouts to be recorded at acquisition date. In comparison, under the previous standards, earnouts were only recognised if, and, when, the payment contingency is resolved. Our results provide evidence that the frequency of stock deals (earnout deals) sharply decreases (increases) since SFAS 141, and this decrease (increase) is strongest among financially constrained bidders, who also decrease their participation in M&A markets. In addition, our results show that SFAS 141(R) diminishes the growth of earnout usage. A Heckman probit model is implemented to address sample selection bias. The implications of these findings for deal design and M&A motivations are discussed.