The Role of Fair-Value Adjustments in Debt Financing

Abstract

Using a novel hand-collected dataset of business combination disclosures, we investigate whether and how fair-value adjustments (FVAs) arising from mergers and acquisitions facilitate debt financing. FVAs are the difference between the fair value and the book value of the target’s net assets. We document that the average corporate acquirer reports economically significant FVAs on non-goodwill assets, showing an increase of 60 percent in the value of the target’s total assets. We find that these FVAs reflect synergies between the target and the acquirer as well as unrecorded economic value on the target’s assets that was not previously captured by historical cost accounting. We then document that FVAs on tangible assets are associated with substantial new debt issuance by the acquiring firm during the three-year period after the transaction. They are also associated with the issuance of cheaper, secured and longer-term debt and with debt that is more likely to have balance sheet covenants. Our findings indicate that FVAs capture new and relevant information about collateralizable assets that is contractible in debt agreements.

Keywords: fair value adjustments, debt contracting, debt financing, mergers and acquisitions, collateral

JEL Classification: M41, G32, G34, G12