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Mergers and Acquisitions Accounting and the Diversification Discount



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    • Custódio is with W. P. Carey School of Business, Arizona State University. This paper is dedicated to the memory of Antoine Faure-Grimaud. I thank Antoine Faure-Grimaud, Daniel Ferreira, and Denis Gromb for invaluable advice and guidance. I also thank Renee Adams, Fernando Anjos, Ulf Axelson, Thomas Bates, Jan Bena, Morten Bennedsen, Vicente Cunat, David DeMeza, Alexander Dyck, Vincent Fardeau, Miguel Ferreira, Cristian Huse, Helena Isidro, Eva Labro, Massimo Massa, Daniel Metzger, Steven Monahan, Joel Peress, Urs Peyer, Gordon Phillips, Christopher Polk, Clara Raposo, Pedro Santa-Clara, Benjamin Segal, Henri Servaes, Kazbi Soonawalla, David Thesmar, Theo Vermaelen, Belen Villalonga, Paolo Volpin, David Webb, the Editor (Campbell Harvey), the Associate Editor, two referees, and seminar participants at Arizona State University, INSEAD PhD Workshop, Instituto de Empresa, London Business School, London School of Economics – Financial Markets Group, Maastricht University, Oxford University, Queen Mary College, Stanford Graduate School of Business, Universidade Nova de Lisboa, Universitat Pompeu Fabra, University of Notre Dame, and University of Washington, and participants at the American Finance Association 2011 Denver meetings for useful comments and suggestions. I acknowledge the support from Fundação para a Ciência e Tecnologia.


q-based measures of the diversification discount are biased upward by mergers and acquisitions and its accounting implications. Under purchase accounting, acquired assets are reported at their transaction value, which typically exceeds the target's pre-merger book value. Thus, measured q tends to be lower for the merged firm than for the portfolio of pre-merger entities. Because conglomerates are more acquisitive than focused firms, their q tends to be lower. To mitigate this bias, I subtract goodwill from the book value of assets and a substantial part of the diversification discount is eliminated. Market-to-sales-based measures do not have this bias.

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