Whither Pooling? - Part II.

• Author: Livingston, Phil
• Position: Brief Article

The comment period on the FASB proposal to eliminate pooling of interests in favor of purchase accounting for all business combinations just closed. Based on my sampling of the letters, this is going to be a tough debate; there are strong positions on both sides. CEOs and CFOs routinely cite mergers and acquisitions as top strategic priorities. Further, the record level of merger activity reflects its importance to corporate efficiency and competitiveness. The FASB is working toward issuing a final standard by year-end 2000, and will hold public hearings to discuss comments on the proposal on Feb. 3 and 4, 2000, in San Francisco, and Feb. 10 and 11 in New York.

Unfortunately, the FASB began the project with a faulty key premise -- that all business combinations are acquisitions. It claims, "an acquisition is an acquisition is an acquisition," and that it's difficult to make clear rules that identify the rare cases of a true merger. But I believe the elimination of pooling will prevent many true mergers that would be beneficial for the companies and their shareholders, as well as their global economic competitiveness. Imposing purchase accounting on such transactions will result in many distorted and largely ignored income statements overwhelmed by purchase accounting charges for goodwill amortization.

Another false assumption of those who favor the abolition of pooling is that it doesn't reflect the merger cost to shareholders and their management teams. This view naively ignores what all good management teams know about the high cost of issuing stock: Management teams are increasingly focused on cash flow per share and earnings per share toward driving their shareholders' per-share value. Issuing stock dilutes the existing enterprise's per-share results. The earnings potential of the acquired company must be significant to cover that dilution. Buyers know when stock is issued, a large part of their own future and growth prospects goes to the seller. This important point is illustrated by the dramatically lower use of stock for acquisitions in the 1980s when equities were significantly undervalued. The cost of issuing stock is real, large and actively considered in dealmaking.

We should retain both methods of accounting, but restrict pooling to those few mergers of equals (DaimlerChrysler and Citigroup, for example). A true...