Purchase Versus Pooling in Stock-for-Stock Acquisitions: Why Do Firms Care

We investigate firms' financial reporting policies with respect to business combinations, particularly the choice between the purchase and pooling-of-interests methods. To control for potentially confounding effects related to the method of acquisition financing, we focus on a sample of stock-for stock acquisitions. We provide evidence that the accounting method choice is jointly determined by the size of the step-up, i.e., the premium paid over the book value of the acquired firm and which is recognized under the purchase method, and proxies for economic benefits derived from accounting-based contracts. In particular, we find that, when the business combination involves a large step-up to the target's net assets, CEOs with earnings-based compensation plans are more likely than others to incur the costs of qualifying for pooling and avoid the earnings 'penalty' associated with the purchase method. However, we find no association between stock-based compensation and the purchase-pooling choice, suggesting managers are not concerned about implications of large step-ups for firms' equity values. We also find no support for the prediction that top executives' preference for pooling is greater when their job security is relatively low. Finally, consistent with the favorable balance sheet effects of the purchase method, we find that the likelihood of pooling decreases with the acquirer's debt-equity ratio, a proxy for debt contracting costs. We also predict and find an association between the purchase-pooling choice and potential costs related to meeting the restrictive pooling criteria. In particular, we find that firms for which the pooling requirement of no share repurchases appears to be binding (firms that have already announced a share repurchase plan and/or have a large number of outstanding employee stock options) are less likely than others to use pooling. However, we do not find that firms for which the requirement of no post-acquisition divestitures of the target's assets may be binding are less likely to use pooling.