Do Boards Consider Post-Acquisition Fair Value Accounting in Determining CEO Compensation?

• In Event: Financial Accounting II

Abstract

FASB ASC 805 (formerly SFAS 141R) requires the assets and liabilities of the acquired firm be recorded at fair value on the consolidated financial statements. Writing acquired assets up to fair value results in excess depreciation and amortization expense, which has a downward effect on earnings of acquiring firms in the post-acquisition period. Since this impact on earnings is due to acquisition accounting rules rather than poor CEO performance, boards may consider excluding this component of the earnings reduction when calculating CEO cash compensation. We empirically test whether the effect of excess depreciation expense is filtered out by boards in awarding CEO cash compensation and find the opposite to be true: on average, excess depreciation expense decreases CEO cash compensation in the post-acquisition period. However, further analysis suggests that two types of boards are more likely to filter out the excess charge: (i) boards consisting of higher percentages of insider directors, and (ii) boards that rely more on cash compensation for awarding CEOs. Our results provide additional evidence for understanding the impact of fair value accounting on firm behavior after acquisition, and are complementary to prior studies that find firms allocate more purchase price to goodwill to avoid the downward effect on earnings due to excess depreciation in the post-acquisition period.

Authors

• Yiting Cao, Cal State University - Los Angeles

• Victoria Dickinson, The University of Mississippi

• Qi Dong, Penn State University - Erie