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Financial Statements

Comparable Financial Statements Help Acquirers Make Smarter Deals

Financial accounting may play an even more important role than previously recognized when it comes to corporate acquisition decisions, according to a UConn professor. 

“It appears that acquirers make better acquisition decisions when target firms’ financial statements exhibit greater comparability with industry-peer firms,” said Todd Kravet, professor of accounting.

“Well-aligned financial statements help acquirers value targets and identify red flags, which leads to better outcomes, as evidenced by higher merger announcement returns, higher acquisition synergies and better future operating performance,”

he said.

Although the Financial Accounting Standards Board and Securities and Exchange Commission have stated that financial statement comparability is beneficial, few prior studies closely examine the relationship.

The study has implications for researchers, regulators and practitioners who are interested in how mergers and acquisitions affect investment efficiency.

“We also found that post-acquisition goodwill impairments and post-acquisition divestitures are less likely when target firms’ financial statements are more comparable,” Kravet said. Acquirers benefit the most when they operate in volatile atmospheres or when management is less familiar with the target business’ core operation.

Todd Kravet (UConn School of Business)

Kravet collaborated with professors Ciao-Wei Chen of the University of Illinois at Urbana-Champaign and Daniel Collins and Richard Mergenthaler, both of the University of Iowa. They have presented their findings at numerous conferences, including the prestigious Contemporary Accounting Research Conference.

Since acquisitions are among the largest and most observable corporate investments, Kravet said, it is important to understand the factors that impact acquisition decisions.

During preliminary investigations, acquirers have limited access to inside information about target firms, and must rely on public information when selecting potential targets and making initial valuation decisions.

The first step of due diligence is a review of the target’s financial statements, enabling the acquirer to compare and contrast them with competitors and identify risk areas that need further examination. The review largely dictates the focus of subsequent research and is particularly important because the acquiring firm typically cannot assess every aspect of the target’s financial well-being, due to time and cost restraints.

The target company’s financial statements may, in fact, be the single most important aspect of that fact-finding mission, Kravet said.

Kravet and his colleagues tested their hypothesis using a large sample of U.S. mergers and acquisitions among publicly listed firms.

“Comparability is an important attribute of accounting information that allows acquirers to better understand the underlying economic events of the target and therefore better evaluate the target relative to other firms,” Kravet said.

Some countries are pushing for the same, universal accounting standards, Kravet said, and his team’s research seems to indicate that more comparable information may improve the flow of capital.

“Our work makes several contributions to the research, namely identifying the economic consequences of financial reporting, examining across-firm accounting attributes and capturing an important, and relatively unique, dimension that is commonly overlooked when assessing the usefulness of accounting information in decision making,” Kravet said.

“In addition, our results are relevant to regulators and standard setters. While both the FASB and SEC emphasize the importance and usefulness of financial statement comparability, our paper answers the call by examining the economic consequences associated with improved acquisition decisions,” he continued.

“Lastly, our study contributes to the merger and acquisition literature by enhancing understanding of how accounting information improves acquisition decisions,” he said.