Bargain Purchase Gains in the Acquisitions of Failed Banks

Abstract

Effective for years beginning on or after December 15, 2008, bargain purchase gains (BPGs) are recorded within income from continuing operations when the fair value of the net assets acquired exceeds the acquisition cost. Although the Financial Accounting Standards Board (FASB) argues that the BPG treatment more faithfully represents the economics of the transaction, they also acknowledge that it creates an opportunity for inappropriate gain recognition. We examine management opportunism and investor valuations regarding the recognition of a BPG using a sample of 142 acquirers that made Federal Deposit Insurance Corporation (FDIC)-assisted bank acquisitions in 2009 and 2010. We find that acquirer banks with relatively strong incentives to boost earnings are more likely to record a BPG, suggesting that firms use the BPG treatment opportunistically. Despite this finding, we observe that the market values the BPGs, albeit with less persistence than the other major components of operating income, and reacts positively to acquisition announcements with BPGs. We explore these seemingly contradictory findings further and find that more suspicious BPGs receive lower valuation multiples. Overall, we provide evidence consistent with managers opportunistically exercising discretion within acquisition accounting and the market differentially pricing BPGs based on underlying incentives to boost earnings.