The Effect of Fair Value Accounting on Firm Public Debt – Evidence from Business Combinations under Common Control

Abstract

We analyze the choice allowed to parent firms under IFRS of how to account for a
business combination under common control (BCUCC), and provide evidence on the motivation
to select fair values and the economic implications of this choice. A BCUCC is a merger of two
firms owned by the same parent. Under IFRS, parent firms can use the acquisition method (fair
values) to record the BCUCC or use assets’ historical cost. We show that parents are likely to
choose fair values when they desire to increase the transparency of their financial reports and when
they likely need to raise capital. Using propensity-score matching, we find that firms that used fair
values are more likely to issue new public debt following the transaction. We also find that the
cost of issuing new debt for these firms is 55 basis points lower than that of comparable firms that
did not do BCUCCs. Our results suggest that using fair values in BCUCCs can increase
transparency and lower firms’ cost of debt.

Keywords: Business combination under common control; real effect of accounting choices; fair value accounting; balance sheet leverage.

JEL Classification: M41, G32, G34, G12