Accounting for takeovers

There can be many motives for corporate acquisitions. Consider the high-minded aim of creating a national champion or the much-touted justification of finding operating synergies. Sometimes the goal is more self-interested - eliminating competition.

Less commonly understood is that the acquiring firm can reap substantial benefits simply from post-acquisition accounting rules.

Once an acquisition is complete, the fair value of the target company’s individual assets and liabilities are consolidated with those of the acquiring company.  Specifically, the pre-acquisition book values of the target are restated at their fair value at the acquisition date through so called “fair-value adjustments” (FVAs). These are typically assessed and certified by auditors.  In other words, once a firm has been acquired, just like the flick of a switch, there’s a change in the accounting treatment of the acquired business’s assets.

What’s more, the great majority of FVAs result in an increase – rather than a decrease – in the reported value of the acquired company’s assets.  The FVAs associated with the target’s tangible assets are economically large: they give a significant boost to the potential collateral available for lenders that provide debt financing. The point? Based on our study of the effect of FVAs on debt financing, we find that an acquirer’s larger collateral base is associated with bigger loans, which can be stretched for longer periods and at lower interest rates.