Accounting Differences Crimp Cross-Border Mergers

More deals occur in countries that follow similar financial-reporting standards, a study finds.
Kathy HoffelderAugust 16, 2012

Dissimilar national accounting standards and the lack of adherence to international financial reporting rules seem to be a major deterrent to companies eyeing targets beyond their borders, according to a recent academic study.

At the same time, cross-border acquisitions by companies of target firms in countries with similar accounting strictures tend to relieve CFOs and other senior executives of financial and administrative burdens, says Shawn Huang, assistant professor at the University of Arkansas and one of the survey’s authors, along with Jere Francis, a professor at the University of Missouri, and Inder Khurana, a professor at the University of Missouri-Columbia. That’s because there’s less of a learning curve involved, Huang notes.

Based on M&A deals in 32 countries that totaled $3.5 trillion between 1998 and 2004, the study finds that differences in local versions of generally accepted accounting principles (GAAP) between an acquirer and a potential target in another country can decrease the number of mergers. Lacking similar standards to their targets, acquirers might find it tougher to identify value-creation opportunities in the first place and to combine the two firms operationally later on, Huang says.

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The study shows that more transactions occurred when the company to be bought and the acquirer operated under similar standards of local GAAP and also adhered to international accounting standards. “GAAP similarities are positively related to the volume of M&A activity over and above a multitude of other country statistics and factors shown to be important in prior cross-country investment literature,” the authors write.

They found that a high number of transactions occurred between the United States and the United Kingdom, where accounting standards are similar. “Among 21 accounting standard items we examined in our study, 81% of them are similar between the U.S. and the U.K.,” says Huang. During the survey’s sample period, there were 1,980 U.S. cross-border M&A transactions targeting U.K. companies (worth a total of $175 billion).

In contrast, between the United States and Germany only 48% of the accounting standards are similar, the authors found. During the period studied, only 877 M&A transactions occurred of U.S. companies targeting German firms (worth $79 billion in all).

“There is a substantial variation in cross-border M&A across countries, which might be explained by differences in GAAP among these countries,” adds Huang.

Strong regulatory enforcement of local GAAP standards also boosted the number of M&A transactions that occurred during the time frame of the study. For those countries with weak enforcement of GAAP, the acquiring firm typically has many challenges when implementing accounting standards, says Huang. In their study, the authors found that countries with the strongest enforcement of GAAP had the highest number of M&A deals transacted.

In a supplement to their GAAP study, the authors also found that the volume of M&A increased within those countries that had similar international financial reporting standards accounting practices as well. After the European Union, for instance, recommended adoption of IFRS for member states in 2005, more cross-border M&A occurred, the authors say. More cross-border deals happened in 2006 than in 2003, when IFRS adoption was first discussed.