M&A Synergies Framework—Accounting and Finance

Updated: Jan 23, 2021

Many potential problems arise in the accounting, IT, and finance areas when bringing together companies with different information systems and reporting regimes. Some are mechanical, but others involve cultural aspects encompassing philosophies and traditions. The accounting and finance cultural differences can be larger than many other cultural differences. A company with reporting practices that are grounded in secrecy, aggressive accounting, or require judgement and estimates will face significant challenges when merging with a company that has opposing practices. Many times, little thought is given when contemplating a merger to the differences in accounting and finance functions. Clashing cultural values in these areas can be difficult to overcome, particularly if they lead to reporting questions from regulatory bodies.

Accounting Methodology

Accounting Standards. Accounting standards vary from country to country. Some countries use their own unique national principles. Many use International Financial Reporting Standards (IFRS), by country regulation or by choice, especially when conducting business on an international level.

Accounting standards are typically one of two types: 1) Rules-based or 2) Principles-based. Rules-based systems tend to have clear, established rules with supporting literature and relevant examples. Principles-based systems (like IFRS) typically have more generalized guidelines—leaving room for interpretation—and often require more disclosure. [note]Forgeas, R. (2008). Is IFRS that different from U.S. GAAP? CPA Insider. Retrieved from http://www.ifrs.com/overview/general/differences.html[/note]  Research has found that there is a higher volume of M&A transactions between countries that have similar accounting standards, especially if the countries have strong enforcement.[note]Francis, J., Huang, S., & Khurana, I. 2016. The Role of Similar Accounting Standards in Cross-Border Mergers and Acquisitions. Contemporary Accounting Research, 33(3), 1298-1330[/note] Unadjusted differences in accounting standards lead to financial misinterpretation. This could cause “non-comparable audit and financial statement results.”[note]Kleinman, G., Lin, B. B., & Palmon, D. (2014). Audit Quality: A Cross-National Comparison of Audit Regulatory Regimes. Journal of Accounting, Auditing and Finance, 61-87[/note] In order to successfully understand the financial situation of the target company, it is important to have resources to understand the method of accounting and properly translate between standards as needed. An M&A transaction will also, likely, require a decision regarding which standards and accounting policies will be used for reporting purposes for the merged company.

Even when typical cultural differences don’t seem remarkably noticeable, the accounting standards of another country might still be quite different, and these discrepancies should not be ignored. For instance, some U.S. investors remain ignorant of the fact that Canadian companies report financial information using IFRS: “‘I’ve been trying to alert investors in the U.S. to this,’ Mr. Rosen [a forensic accountant and analyst] said in an interview. ‘But there’s just that belief that Canada is following U.S. standards when it’s not.’” [note]Stander, S., Buys, P., & Oberholzer, M. (2013). Using the Cultural Dimension and Accounting Value Classification Frameworks to Investigate Cultural Diversity in a Multi-National South African-Based Company. Managing Global Transitions 11(3). 313[/note] That misunderstanding could lead U.S. investors to make incorrect assumptions and make misguided investments.

Beyond the required accounting standards, basic procedures of an accounting or finance department may need to be re-examined in order to obtain the best result in an M&A transaction. One example of this comes from a French company’s recent acquisition of a South African company: “As part of the South African management team, a key phrase in this stage was no holy cows, meaning that all processes and procedures were challenged so that only the best, either French or South African, was maintained or incorporated. This could be a key reason why the acquisition of the organisation was such a success.” [note]Morgenson, G. (2017). Warren Buffett Invests in Canada, but Should You? The New York Times. Retrieved from https://www.nytimes.com/2017/07/07/business/warren-buffett-investing-canada.html?_r=0[/note] Because the team members on both sides were open to re-examining the reporting policies and processes of the financial department, rather than just blindly insistent on following habitual techniques, the combined company was able to carry on only the best from each culture. Companies should spend resources to pinpoint potential differences in accounting methods before an acquisition: this will allow them to value the target company more accurately.

Valuation. Culture can impact the way an acquiring company values a target company. Research has shown that some companies in certain countries have a tendency to present higher offers for M&A. This may be due to an expectation of growing profits, as an incentive for the target to overcome difficult regulations, or a belief in the long-term importance of the investment.[note]Sherman, A. & Browning, J. (2016). China’s Buying Spree Shows Force of Desire for U.S. Firms. Bloomberg Technology. Retrieved from https://www.bloomberg.com/news/articles/2016-02-26/china-s-pricey-buying-spree-shows-force-of-desire-for-u-s-firms.[/note] The concept of different timeline expectations is in part captured by Hofstede’s long-term orientation dimension and the GLOBE study’s future orientation. Both present the idea of decision-making differences and relative horizons. However, acceptance and application of these two values is mixed in the academic world.[note]Venaik, S., Zhu, Y., & Brewer, P. (2013). Looking into the future: Hofstede long term orientation versus GLOBE future orientation. Cross Cultural Management: An International Journal. 20(3). 361-385[/note] Here, we have narrowed and clarified the definition just to the financial aspect of horizon differences since it is one of the most prominent and measurable evidences of different decision-making mindsets.

Research suggests that companies in under-developed countries are inclined to offer higher bids, potentially out of a sense of accomplishment and national pride. [note]Hope, O., Thomas, W., & Vyas, D. (2011). The cost of pride: Why do firms from developing countries bid higher? Journal of International Business Studies, 42(1), 128-151[/note] In particular, Asian countries tend to offer higher premiums. [note]Chazen Global Insights. (2015). Why M&A Is Different In Japan. Columbia Business School. Retrieved from

https://www8.gsb.columbia.edu/articles/chazen-global-insights/why-ma-different-japan[/note] Additionally, valuation discrepancies can be explained by differing valuation methods, accounting standards and professional behaviors.

One example of differing valuation is that of Japan’s Softbank. As of 2012, Softbank’s 70% stock acquisition of Sprint was the priciest ever from a Japanese company. This could, in large part, be explained by the very long-term horizon under which the Japanese managers are operating: “SoftBank Group Corp.’s Masayoshi Son has a 300-year plan, so if combining Sprint Corp. and T-Mobile US Inc. takes a few years longer than he hoped, that’s OK.” [note]Sherman, A., Shields, T., & Moritz, S. (2016). Sprint Owner Said to Still Hold Out Hope for T-Mobile Deal. Bloomberg. Retrieved from https://www.bloomberg.com/news/articles/2016-08-17/sprint-owner-is-said-to-still-hold-out-hope-for-a-t-mobile-deal[/note] This extreme example shows that high-value stock acquisitions can be attributed to the Asian market tendency to offer high premiums for acquisitions considered to be of long-term value. Merging companies should be aware of this practice to understand the reason behind valuation practices of their partnering company.

Professional Behavior

Professionalism vs. Statutory Control (Gray). The degree to which individual judgment is used is defined on a scale ranging from professionalism to statutory control. Professionalism refers to the degree of use of subjective appraisal of information by each individual accountant and by the general accounting profession. Countries that prefer more rigid statutory control and legal requirements delineating accounting decisions view the accounting profession as a career of rule- following are on the statutory control end of the spectrum.[note]Gray, S. (1988); Towards a Theory of Cultural Influence on the Development of Accounting Systems Internationally. Abacus, 24(1), 1-15 Waterstraat, S.K. (2015). Cultural Significance on Accounting: Analyzing the Link between Uncertainty Avoidance and Accounting Conservatism in the Hofstede-Gray-Framework. (Unpublished doctoral dissertation). University of St. Gallen, St. Gallen, Switzerland[/note] Cultures preferring professionalism typically use more disclosure to clarify judgments and interpretations of accounting standards.

One recent study of Russian accounting culture illustrates this cultural difference. Based on Russia’s categorizations under Hofstede’s studies, Russians demonstrate a strong preference for statutory control and view the accounting profession as focused on following rules. This proved accurate after extensive interviewing of Russian professionals: “[…] there was a unanimous consensus that having no choices in selecting various accounting treatments and having clear instructions would improve the standards considerably.” In addition,

Moving on with the interview, accountants were asked if they were comfortable with exercising their own professional judgement. A large majority (75 percent) said ‘no’. A general consensus on that matter was that there is no need to make own judgements while preparing financial statements, as there are rules that need to be followed, otherwise ‘you can break the law’, was the response of many accountants. [note]Combs, A., Samy, M. & Myachina, A. (2013). Cultural impact on the harmonisation of Russian Accounting Standards with the International Financial Reporting Standards: A practitioner’s perspective. Journal of Accounting & Organizational Change, 9(1),42[/note]

This is in contrast to the typical mindset of U.S. accountants, which argues that the educated judgment of a well-trained professional is more important than strict, prescriptive statutes. Recognizing the cultural preference of both companies in a merger will be of great value to each and help clarify differences in accounting mindsets and prepare each counterpart country for the variability in accounting and reporting across cultures. Figure 4.1 illustrates the spectrum of professionalism versus statutory control cultures.

Figure 4.1: Adapted from Gray 1988

Uniformity vs. Flexibility (Gray). Uniformity versus flexibility has been a long-debated topic amongst accountants. Uniformity refers to the preference for consistency in accounting practice and reporting between companies and across different time periods, while flexibility allows for the interpretation of rules and presentation to meet individual circumstances. [note]Gray, S. (1988). Towards a Theory of Cultural Influence on the Development of Accounting Systems Internationally. Abacus, 24(1), 1-15[/note] To accurately understand the past activity of a company and its possible future growth, it is key to understand a country’s preference towards uniformity or flexibility. A difference in preference leads to a difference in accounting for similar transactions, which may result in misinterpretation of a company’s financial statements. Research suggests that a uniform approach generally leads to better comparability. [note]Cole, V., Branson, J., & Breesch, D. (2012). The uniformity‐flexibility dilemma when comparing financial statements: Views of auditors, analysts and other users. International Journal of Accounting &Information Management, 20(2), 114-141[/note] Figure 4.2 illustrates the spectrum of flexibility versus uniformity cultures.

Figure 4.2: Adapted from Gray 1988

In the study of Russian accountants, the preference for uniformity was strongly expressed. The accountants mentioned that although the Russian Accounting Standards allowed for some diversions from certain rules in order to more accurately represent the full and fair financial situation of the company, none of the interviewees had departed from the rules but instead preferred a systematic approach.[note]Combs, A., Samy, M, & Myachina, A. (2013). Cultural impact on the harmonisation of Russian Accounting Standards with the International Financial Reporting Standards: A practitioner’s perspective. Journal of Accounting & Organizational Change, 9(1), 26-49[/note] Accountants in Anglo countries, however, prefer adapting accounting standards according to individual circumstance. In Anglo countries (other than the U.S.), there exists the mindset and notion of “true and fair override,” which permits a company to deviate from accounting rules if an alternative provides a more accurate reflection of a company’s accounts. Since a difference in preference between uniformity and flexibility exists, companies should research accounting practices of their target nations to achieve a more comparable financial valuation.

Conservatism vs. Optimism (Gray)

Conservatism applies to a cautious measurement approach that tends to choose less aggressive, “worst-case scenario” accounting measurements. Optimism is the opposite, relating to an optimistic, risk-taking, “best-case scenario” approach to measurement. Identifying the disparity between the two accounting approaches is crucial to understanding the value of merging companies. For example, “one strain of research finds that conservatism causes companies’ income to be less persistent over time.”[note]Tinkelman, D. P. (2015). Introductory Accounting: A Measurement Approach for Managers. Routledge.[/note] Additionally, “companies with conservative accounting are slow to assume that good things have happened, and quick to assume that bad things have happened. They show lower income and assets than companies with more optimistic accounting.”[note]Tinkelman, D. P. (2015). Introductory Accounting: A Measurement Approach for Managers. Routledge.[/note] This advice serves as a warning to merging companies: confirm if a company’s accounting is conservative or optimistic to help determine what a company is worth. Figure 4.3 illustrates the spectrum of optimism versus conservatism cultures.

Figure 4.3: Adapted from Gray 1988

One example of these different accounting tendencies was seen in the aftermath of British HSBC’s merger with Household, a U.S. subprime lending business. Both the U.S. and the U.K. are classified as “Anglo” cultures, which Gray theorized to be the most optimistic of all the culture groupings. HSBC’s overly optimistic accounting came to light during the global financial crisis:

One of the major areas of concern is over the way HSBC accounts for Household’s assets. The bank carries Household’s loans at ‘book value’, an approach that looks at their worth over the course of the loan. Some analysts have said HSBC will come under pressure to use a harsher ‘fair value’, which could leave it with a large capital shortfall. HSBC has denied there is a problem.[note]Griffiths, K. (2009). HSBC’s Global Reputation Takes Massive Hit from American Misadventure. The Telegraph. Retrieved from http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/4903651/HSBCs-global-reputation-takes-massive-hit-from-American-misadventure.html[/note]

Optimism is demonstrated in this case by the bank continuing to value the loans (assets, from the perspective of the lender) at historical values that were likely too high. Although optimism doesn’t always cause controversy and financial distress, it did in this case, and revealed a possible cultural tendency towards optimistic accounting.

Secrecy vs. Transparency (Gray)

Secrecy allows for confidentiality of information on a need-to-know basis while transparency provides a willingness to disclose information to the public. The concept of transparency is that a company discloses enough information so that others can fully understand its accounting and financial practices. Different countries tend to have inclinations for or against transparency. There are incentives for both tendencies. Author Daniel Tinkelman advises:

[Management] may be afraid that their workers will ask for higher pay if they know the business can afford it, or that competitors will offer special deals to the company’s best customers and employees. If the business is doing poorly, the company may fear that its suppliers and banks will stop dealing with it. On the other hand, shareholders will not buy the company’s stock, and suppliers and lenders won’t deal with it, unless the company discloses enough information to make these outside parties comfortable.[note]Tinkelman, D. P. (2015). Introductory Accounting: A Measurement Approach for Managers. Routledge.[/note]

Research also suggests that within accounting, “transparency is higher in countries with legal/judicial regimes characterized by a common law legal origin and high judicial efficiency. In contrast, financial transparency is higher in countries with low state ownership of enterprises, low state ownership of banks, and low risk of state expropriation of firms’ wealth.”[note]Bushman, R. M., Piotroski, J. D., & Smith, A. J. (2004). What Determines Corporate Transparency? Journal of Accounting Research, 42(2), 207-252[/note]  Figure 4.4 illustrates the spectrum of transparency versus secrecy cultures.

Figure 4.4: Adapted from Gray 1988

After Dutch company Unilever acquired American’s Ben & Jerry’s, staff had to learn new accounting practices to comply with Unilever’s level of transparency.

“In guiding the integration, Couette and other senior managers at Ben & Jerry’s worked to establish a number of organizational processes and controls to assure financial transparency and ease of communication between Ben & Jerry’s and the whole of its parent company. Employees were required to learn new accounting and financial reporting procedure, to enter and retrieve data through new software and computer systems, to complete new intra-office forms, and so on.”[note]Austin, J. & Quinn, J. (2007). Ben & Jerry’s: Preserving Mission and Brand within Unilever. Harvard Business School Cases. Retrieved from https://www.thecasesolutions.com/wp-content/uploads/2014/06/Case-Ben-Jerrys-Preserving-Mission-and-Brand-within-Unilever.pdf[/note]

The U.S. and the Netherlands reside on opposite sides of the optimism scale, with the U.S. exhibiting more optimistic tendencies than the Dutch.

In another M&A transaction, Cadbury, a UK company, emphasized transparency in its acquisition of the U.S. company Adams. Both cultures are considered to be Anglo and very transparent, according the theories of Sidney Gray. That conclusion is supported in the way that Cadbury insisted on transparent communication of synergy goals: “Cadbury’s synergy tracking and reporting system was built with full cooperation and input from the Cadbury CFO’s team, with occasional meetings between the PMO [Project Management Office] and the CFO’s office to ensure that the self-reported results were actually showing up in ‘official’ financial results and budgets.” [note]Ficery, K., Herd, T., & Pursche, B. (2007). Where has all the synergy gone? The M&A puzzle. Journal of Business Strategy, 28(5), 34.[/note]  Knowing the typical level of optimism of a nation will give acquiring companies an idea of how much information a company provides to the public.

Fraud/Earnings Management. Managers have incentives to alter reported firm earnings to maximize company and personal wealth. These incentives can be either explicit, through contracts and compensation plans, or implicit, through customer and supplier expectations.[note]Becker, C., DeFond, M.L., Jiambalvo, J. & Subramanyam K.R. (1998). The Effect of Audit Quality on Earnings Management. Contemporary Accounting Research, 15(Spring), 1-24[/note]  Research suggests that earnings management, particularly earnings smoothing, is driven by culture. Cultures with higher uncertainty avoidance and greater collectivism are more likely to engage in earnings smoothing, the practice of manipulating the timeline of income streams to create a more conveniently consistent flow. [note]Doupnik, T. (2008). Influence of Culture on Earnings Management: A Note. Abacus, 44(3), 338[/note]  In addition, countries with weaker legal enforcement of investor protection and minority shareholder rights also experience more earnings management.[note]Leuz, C., Nanda, D., & Wysocki, P. 2003. Earnings management and investor protection: An international comparison. Journal of Financial Economics, 69, 526[/note]  Transparency International provides a Corruption Perception Index (CPI), which rates countries on the level of corruption of their public sectors. Transparency.org is regularly updated with the latest CPI to inform the public about transparency of governmental and economic actions, as well as corruption issues. Countries that are considered “less developed” tend to experience more corruption issues (see Figure 4.5), [note]Transparency International. (2017). Corruption Perceptions Index 2016. Retrieved from https://www.transparency.org/news/feature/corruption_perceptions_index_2016[/note]  which can carry through into the business and accounting realm. [note]Transparency International. (2017). Corruption Perceptions Index 2016. Retrieved from https://www.transparency.org/news/feature/corruption_perceptions_index_2016[/note]

Figure 4.5: Adapted from Transparency International

The practice of “earnings management” can easily be classified as fraud if companies intentionally misstate information. Both acquiring and target companies have a greater incentive to manage earnings before the merging process (often called “window dressing”). This practice is common since an increase in firm value can have a large monetary benefit, for example through larger manager buyouts or higher premium prices. Target companies and investors should be aware of the financial standing of the acquiring company because “empirical evidence…suggests that acquirers, particularly those financing the deal with the issue of shares, engage in income-increasing accrual manipulation in the period preceding the bid announcement in the hope of raising the market price of their stock, and therefore reducing the cost of buying the target.”[note]Botsari, A. & Goh, L. (n.d.) Earnings Management Ahead of M&A: Can Corporate Governance Make The Difference? Retrieved from CiteSeerX[/note] Merging companies should be wary of earnings management practices, especially considering the ease of justifying accounting differences through reference to cultural misunderstanding.

To minimize the chance of earnings management, research found that firms with no fraud had a higher number of outsiders on the company’s board of directors. The reason for this is because “the inclusion of outside members on the board of director increases the board’s effectiveness at monitoring management for the prevention of financial statement fraud.”[note]Beasley, M. (1996). An Empirical Analysis of the Relation Between the Board of Director Composition and Financial Statement Fraud. The Accounting Review, 71(October), 443-465[/note] Additionally, “high-quality auditing acts as an effective deterrent to earnings management because management’s reputation is likely to be damaged and firm value reduced if misreporting is detected and revealed.”[note]Becker, C., DeFond, M.L., Jiambalvo, J. & Subramanyam K.R. (1998). The Effect of Audit Quality on Earnings Management. Contemporary Accounting Research, 15(Spring), 1-24[/note]  Again, the Corruption Perceptions Index may provide useful information in determining which countries have a greater likelihood to experience some degree of corrupting influences in the corporate sphere.

“The failure to identify alleged corrupt activity in the course of a corporate transaction can have an even more dramatic impact on a company.”[note]Sherman, A. J., & Cook, R. C. (2011). International Mergers: How to Detect Corruption. The Journal of Corporate Accounting and Finance[/note] There is a thin line between earnings management and fraud.  There should be “a clear conceptual distinction between fraudulent accounting practices (that clearly demonstrate intent to deceive) and those judgments and estimates that fall within accounting standards and which may comprise earnings management depending on managerial intent.”[note]Dechow, P. M., & Skinner, D. J. (2000). Earnings Management: Reconciling the Views of Accounting Academics, Practitioners, and Regulators. Accounting Horizons, 235-250[/note]

Recent literature and news sources provide modern-day examples of earnings management and fraud. For example, when Caterpillar Inc. acquired ERA Mining Machinery Ltd., goodwill was written down soon after the merger took place. “The U.S. equipment maker said last week that it would write off $580 million of the about $700 million it paid in June to buy ERA Mining Machinery Ltd., a Chinese maker of mine-safety equipment. Caterpillar alleged “accounting misconduct” at ERA, including overstatements of its profit in the years before the acquisition. It didn’t name anyone it suspected of the alleged misconduct.”[note]Areddy, James T. (2013) Unusual Roots for Firm in Caterpillar Scandal. Wall Street Journal (Online)[/note]  This earnings management scenario ended up causing a large loss for the acquiring company.

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