Accounting for Acquisitions and Firm Value (Manuscripts‪)‬

ABSTRACT The accounting of an acquisition is based on either the pooling or the purchase method. Pooling (or pooling of interests) treats the combined companies (acquirer and acquired) as though they had always operated as one company. The purpose of this study is to investigate the extent to which the accounting method used affects the value of the acquiring firm. One argument is that the accounting method used should not affect this value inasmuch as the accounting method does not directly affect cash flow. Our sample consists of 146 pooling and 46 purchase announcements from 1981 to 1995. Results indicate that valuation effects are more favorable for acquisitions using the purchase method in the eleven-day period surrounding the announcement and for at least six months following the announcements. These results stand even after conducting a cross-sectional analysis that controls for the firms' price/earnings ratio, size, market parameter estimates, earnings surprises, and leverage. These results suggest that market participants value the added flexibility and indirect tax benefits that are provided by the purchase method of accounting as opposed to the higher reported future earnings associated with the pooling method.