A study of selected tax and accounting influences on merger premia

Although business combinations are neither a new nor infrequent phenomenon, a review of the related literature suggests that the price formation process surrounding them continues to be debated. Differing accounting standards and differing tax laws have the potential to affect the price formation process in cross-border acquisitions. A natural testing ground to examine these international differences is the UK because of recent changes in US tax law and in UK financial reporting requirements. Recent changes in the UK's financial reporting standards provide an opportunity to examine acquisitions where the US and UK have differing financial reporting requirements for goodwill and where the requirements are the same. Until 1998, UK firms were able to write-off goodwill directly to equity reserves, bypassing the income statement entirely. US firms have been required to amortize and expense goodwill. All else being equal, this differing treatment gives UK firms an earnings advantage. From 1998, UK firms are required to take amortization of goodwill through the income statement, effectively ending the earnings advantage. This earnings advantage could translate into higher premia, where premia is defined as the difference between acquisition price and preacquisition market value. Goodwill is not tax deductible in the UK, and it has only been deductible for tax purposes in the US since 1 993. This provides an opportunity to examine acquisitions where the US and the UK have the same requirements for tax deductibility of goodwill and where the requirements differ. Since a tax advantage translates into a cash flow advantage, US acquirers may be willing to pass some of this tax savings on to the target in the form of additional premium. Contrary to expectations, 1 find no difference between UK and US firms despite the tax and financial differences. Failure of any differences to emerge raises questions about the importance of accounting and tax treatments of goodwill in the price formation process for cross-border acquisitions.