Fair Value Accounting and Firm Indebtedness – Evidence from Business Combinations Under Common Control

We analyze a choice that parent firms face under IFRS: whether to account a business combination under a common control (BCUCC) at fair value or at the historical cost, to provide evidence that firms would use fair value when they believe it would help them issuing public debt. A BCUCC is a merger of two entities owned by the same parent firm. Although most of BCUCCs do not materially change the composition and the market value of parent firm’s assets and liabilities, they can significantly reduce accounting leverage of the parent firm if recorded at fair value. We find that parent firms are more likely to record BCUCCs at fair value when their pre-BCUCC leverage is high and when they have net worth covenants on their debt. Using a propensity score to match firms that used fair value to account for a BCUCC with similar firms that did not conduct a BCUCC, we find that the former are more likely to issue new public debt following the BCUCC.