In M&A Accounting, Poolings Have Poor Track Record Boosting Income

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Companies using the merger accounting method adopted in many recent bank deals have been turning out subpar returns for shareholders, a study indicates.

In a review of U.S. bank and nonbank mergers worth more than $1 billion, a New York-based management consulting firm found that companies accounting for their deals as poolings of interest failed to beat similar companies' performance 78% of the time.

But companies that accounted for their acquisitions as purchases outperformed their peers 52% of the time during the three-year period examined, Mitchell Madison Group found.

Banks and other companies have turned to the pooling method in part because it is easier to sell deals to shareholders when the premium paid for the acquisition need not be deducted over time from earnings.

In practice, according to Mitchell Madison, the less stringent accounting appears to have led to lax management.

"Purchase accounting provides management the incentive to rebuild earnings," said Kenneth W. Smith, a partner in charge of Mitchell Madison's M&A research program. "With poolings, the same level of urgency isn't there, nor may post-merger managements feel the same level of accountability."

The findings are especially relevant for investors in banking companies. Since September, 257 bank mergers have been accounted for as poolings and 144 have been purchases, according to Sheshunoff Information Services. That's a drastic change from 1996, when only 121 mergers were poolings and 262 were purchases.

In purchase deals, the price paid above a company's net worth-called goodwill-is deducted from the buyer's reported earnings per share for many years. For example, Mellon Bank Corp., which almost always uses purchase accounting, reported second-quarter earnings of 81 cents per share on a diluted basis but 91 cents per share when the goodwill from its acquisitions is accounted for.

In a pooling transaction, the two companies' balance sheets are combined-or pooled-without revaluing the historical costs of the firm's assets. Because no goodwill is involved, the merged company's reported earnings look "cleaner."

But a cleaner balance sheet does not necessarily make for a more vibrant company, Mr. …