THE VALUE RELEVANCE OF EARNINGS AND BOOK VALUE UNDER POOLING AND PURCHASE ACCOUNTING

This study examines the value relevance of reported earnings and book value under pooling-of-interests and purchase accounting. Using a sample of 110 merger or acquisition transactions from the period 1988 to 1996, the value relevance of the two accounting approaches is investigated by examining the correlation of post-merger earnings and book value with share price. Regression analysis using Ohlson's (1995) valuation model is conducted for the merger year (m) and the subsequent year (m + 1) using three samples (pooling only, purchase only and a combined sample). The results are as follows: When pooling accounting is used, only earnings are value relevant, and the results are consistent with earnings under pooling being more value relevant than book value. When purchase accounting is used, both earnings and book value are value relevant and no significant difference was found between the value relevance of earnings and book value. A Vuong test indicates that the adjusted R-2 of the valuation model under purchase accounting significantly exceeds that under pooling for the merger year only for the combined sample. Thus, this result provides weak evidence that the earnings and book value under purchase accounting better explain firm value than those under pooling. The relative value relevance of earnings and book value under the two methods is pooling earnings> purchase earnings and purchase book value> pooling book value. Using proxy variables for earnings and book value reflecting the consolidation framework of Statement of Financial Accounting Standards (SFAS) Nos. 141 and 142, the results indicate that the proxy variables yield earnings and book value data that better explain firm value than those produced using either pooling accounting or purchase accounting for half of the testing periods and sample groups. Thus, our results provide some evidence to support the FASB's decision to eliminate pooling accounting.