Pooling vs. Purchase: The Effects of Accounting for Mergers on Stock Prices

Abstract

Whether the method of accounting for mergers affects the stock prices of the acquiring firm is investigated in this article. Many observers believe that companies using the pooling-of-interests method in an acquisition with positive goodwill enjoy higher stock prices because of the higher earnings they report when using this method. An efficient capital market, however, should be able to see through the particular accounting convention used to describe an event, such as a merger, and respond to the economics of the merger, not its accounting description. The study analyzes a sample of pooling-of-interests mergers in the 1954-1964 period, and finds no abnormal price movements in the period surrounding the merger or the earnings announcements immediately after the merger. Conversely, some evidence of higher stock prices in the period preceding a merger for a much smaller sample of companies using the method is found. The authors conclude that the pooling-of-interests method does not lead to abnormal stock price behavior for acquiring firms. C ONSIDERABLE evidence has been assembled in recent work supporting the Efficient Capital Markets Hypothesis. ' The hypothesis has important implications for external accounting practices. Indeed, several recent studies have looked at the informational content of alternative accounting methods and their effects on stock prices.2 Accounting changes or manipulations not accompanied by real economic impacts seem to have no statistically significant effects on stock prices. Apparently, the presence of alternative and more timely sources of information on corporate performance enables investors to look beyond simple income numbers in valuing equity securities. Accounting for business combinations has been an especially troublesome issue for accountants. Up until APB 16 was issued in October 1970, business combinations which were accomplished by means of an exchange of securities could have been accounted for either by the purchase method or the poolingof-interests method. Such combinations are almost always nontaxable exchanges so that there is no difference in the cash flows associated with using one method or the other. Therefore, differences in reported earnings between the two meth' For a summary of the early theory and empirical work on the Efficient Markets Hypothesis, see Fama [1970]. See also Beaver [1972] and Kaplan [1978] for the relevance of the hypothesis to the generation and interpretation of financial accounting numbers. 2 Kaplan and Roll [ 1972 ], Ball [ 1972 ], Sunder [ 1973 ]. Hai Hong is Assistant Professor at Northwestern University; Robert S. Kaplan is Professor at Carnegie-Mellon University and Gershon Mandelker is Associate Professor at the University of Pittsburgh.

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