Contentious Valuations: Accounting Reports as Schelling Points

Abstract

This paper advances a new framework for understanding a use case for financial accounting, as anchoring Schelling points for institutional valuations. 'Institutional' denotes cases in which valuations are advanced to persuade parties to a collective agreement, such as M&A and bankruptcy. The parties in such settings face a problem with elements of a Keynesian beauty contest. The solution is a Schelling point, a choice that parties anchor on because they expect others to do the same for the same reason. A key question in such games is how that higher-order belief is grounded. Financial reporting has the properties that classically create Schelling points. I test the theory that financial statements form Schelling points for institutional valuations using the setting of M&A valuation disclosures. I find that M&A advisors predominantly use trailing multiples, of reported measures, even though it is common knowledge (to both the advisors and their prospective opponents) that forward multiples are better for accurate valuation. This is more pronounced in deals with more salient coordination and higher-order belief problems. Alternative explanations based on prior frameworks are ruled out. I contribute by explaining valuation practice in M&A, and introducing this framework for understanding how accounting functions in such settings. Applying a higher-order belief lens to understand valuation practice and decisions within institutional settings of this type presents a promising research agenda.

Keywords: M&A, Appraisal, Valuation, Accounting Multiples

JEL Classification: G30, G32, M41, G34