30 Pages Posted: 22 Mar 2010 Last revised: 8 May 2013
Date Written: January 21, 2013
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.
Keywords: Diversification discount, M&A Accounting, Accounting Goodwill, Excess value, Tobin's q
JEL Classification: M41
Suggested Citation: Suggested Citation
Custodio, Claudia, Mergers and Acquisitions Accounting and the Diversification Discount (January 21, 2013). Journal of Finance, Forthcoming; AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1573039 or http://dx.doi.org/10.2139/ssrn.1573039