Mergers and Acquisitions Accounting and the Diversification Discount
New University of Lisbon - Nova School of Business and Economics
January 21, 2013
Journal of Finance, Forthcoming
AFA 2011 Denver Meetings Paper
This paper shows that q-based measures of the diversification discount are biased upward by mergers and acquisitions activity and its accounting implications. The most common procedure to estimate the discount is to compare a conglomerate's q with that of a benchmark portfolio of focused firms. Under purchase accounting, the acquired assets are reported at their transaction-implied value in the acquirer's balance sheet. Since the transaction value typically exceeds the target's pre-merger book value, measured q tends to be lower for the merged firm than for the portfolio that combines both pre-merger entities. Because conglomerates are more acquisitive than focused firms, their measured q tends to be lower. To mitigate this measurement bias, I subtract goodwill from the book value of assets. This correction eliminates a substantial part (but not all) of the diversification discount estimated with q-based methods. Market-to-sales measures of the diversification discount should not be affected by these mergers and acquisitions effects. Evidence of the diversification discount persists when market-to-sales is used. These results cast serious doubt on these widely used methods.
Number of Pages in PDF File: 30
Keywords: Diversification discount, M&A Accounting, Accounting Goodwill, Excess value, Tobin's q
JEL Classification: M41
Date posted: March 22, 2010 ; Last revised: May 8, 2013
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