Journal of Financial

Economics 39 (1995) 353-378

An analysis of value destruction in AT&T’s acquisition of NCR
Thomas Lys*~“, Linda Vincentb
“J.L. Kellogg Graduate School of Management, Northwestern University, Evanston, IL 60208, USA “Graduate School of Business, University of Chicago, Chicago, IL 6063 7, USA (Received August 1992; final version received March 1995)

Abstract AT&T’s $7.5 billion acquisition of NCR decreasedthe wealth of AT&T shareholders by between $3.9 billion and $6.5 billion and resulted in negative synergies of $1.3 to $3.0 billion. We find that AT&T paid a documented $50 million and possibly as much as $500 million to satisfy pooling accounting, thus boosting EPS by roughly 17% but leaving cash flows unchanged. We conclude that AT&T’s decision to acquire NCR in what the market perceived as a value-destroying transaction was related at least in part to the 1984 consent decree with the Department of Justice that led to the break-up of AT&T.
Key words: Mergers; Acquisitions; Purchase; Pooling JEL classijication: G34; M41

1. Introduction After almost six months of hostile maneuvering, NCR agreed to be acquired by AT&T in an all-stock transaction valued at $7.5 billion. This was the largest



Financial support from Deloitte & Touche, KPMG Peat Marwick, and the Accounting Research Center at the J.L. Kellogg Graduate School of Management, Northwestern University, is gratefully acknowledged. We are indebted to Robert C. Holder, President of AT&T Computer Systems (and previously head of the transition team for the purchase of NCR), for answering numerous questions about this merger in discussions on December 6, 1991. We have benefited from the comments of W. Bruce. Johnson, Steven N. Kaplan, Margaret Neale, Lawrence Revsine, Michael C. Jensen (managing editor), Richard S. Ruback (editor), and William Fruhan and Victor Bernard (referees.) 0304-405X/95/%09.50 0 SSDI 0304405X9500831 1995 Elsevier Science S.A. All rights reserved X


T. Lys. L. Vincent/Journal

of Financial Economics 3Y (19951 353-378

public financial transaction in 1991 as well as the largest computer industry merger to date. AT&T persisted in its pursuit of NCR despite the security market’s initial and consistently negative reactions to the proposed deal. AT&T shareholders lost between $3.9 and $6.5 billion in market value during the negotiations. Upon completion of the transaction, investors assessedAT&T’s overpayment for NCR at between $60 and $101 per share on a final bid price of $111 per share. We explore the motivation behind AT&T’s strategy to acquire NCR as well as its determination to proceed with what the market perceived to be a valuedestroying transaction. We also examine why AT&T was willing to pay as much as $500 million extra for NCR to satisfy requirements to use the pooling-ofinterests (pooling) accounting method rather than the purchase method, even though the accounting method had no direct cash flow implications for this deal. Our analysis suggeststhat AT&T’s management initiated the acquisition of NCR in order to save face for perceived past management mistakes stemming from the 1984divestiture of the Bell operating companies. AT&T’s management pursued the acquisition, despite NCR’s resistance and the market’s consistently negative reaction to the deal, becauseof a combination of hubris, bad judgment, and escalation of commitments. Although this assessmentis made with the benefit of hindsight, we document that there were clear indications that AT&T would have difficulty succeedingin this acquisition becauseof the dismal history of similar mergers and management’s limited experience in a competitive environment. AT&T preferred the pooling method of accounting to avoid the decreasein future earnings per share (EPS) that would result from the purchase method. We also find that AT&T successfully lobbied the SEC to grant approval for pooling, despite several violations of the requirements for pooling. The next section describes the background and motivation for AT&T’s acquisition of NCR. Section 3 analyzes investors’ reactions to the acquisition as well as the relative costs and benefits of the acquisition. Section 4 documents the magnitude of the incremental costs of pooling as well as possible reasons for AT&T’s willingness to pay for the opportunity to use pooling. Section 5 discussesexplanations for AT&T’s completion of this merger despite repeated and unambiguous indications that investors did not view NCR as a value-enhancing acquisition. Finally, Section 6 provides a summary and our conclusions. 2. AT&T’s motivation for purchasing NCR AT&T was founded in 1885 and, as a regulated utility, enjoyed a virtual monopoly of long-distance telephone service and equipment manufacture for almost a century. In 1974, the Department of Justice (DOJ) brought a civil antitrust action against AT&T for monopolizing telecommunications services and equipment. This suit sought divestiture of AT&T’s equipment manufacturing

and 1987 Annual Reports. The current CEO. We will continue to sell them on a standalone basis. For example. AT&T’s management believed that its future lay in linking telecommunications with computer operations and considered the divestiture an opportunity to expand into new areas of information services as well as to capitalize commercially on its accumulated expertise in both telecommunications and data processing (e. . AT&T’s management stressedthe net benefits to be obtained from signing the consent decree in its external communications.) and the separation of its longdistance services (AT&T Long Lines Department) from the Bell operating companies which would then provide only local telephone service.Given the changing nature of the telecommunications industry. After fighting the DOJ for several years. but in a larger context we view computers as a vital element in the development and implementation of information networks. .AT&T’s Chairman of the Board and CEO reconfirmed this commitment to the computer business in the 1985. computeroriented endeavors..Allen wanted the company to be technology-driven and to provide an . . as exemplified by not only the antitrust action against AT&T but also the results of the FCC’s Second Computer Inquiry (in which the FCC ruled in 1981 that enhanced services and customer premises equipment would be detariffed) and the court’s 1974 ruling that AT&T had to supply accesslines to its competitor.including the UNIX operating system). However.This criticism intensified when the DOJ dropped its concurrent antitrust suit against IBM several months after AT&T’s capitulation. Inc. took office in 1988 and part of his stated strategic vision was to make AT&T a significant player in the computer business. p. effective January 1.g. 1984. Lys. AT&T’s management was roundly criticized in the financial press for signing the consent decree. the 1984 Annual Report (p. 1986. Our vision is to link computers and other customer premises equipment with public and private network facilities . The decree required AT&T to divest the Bell operating companies. AT&T signed a consent decree in early 1982. AT&T’s management believed that it had no choice but to alter its strategy for the future. stating (1986 Annual Report. . in exchange for the right to enter into previously prohibited (except for internal activities).’ None of this was possible under the pre-consent decree regime. Robert Allen. The consent decree. L. Vincent/Journal of Financial Economics 39 (1995) 353-378 355 subsidiary (Western Electric Company.AT&T’s Bell Labs had pioneered significant developments in computer science. computers are an intrinsic part of our business. allowed AT&T to sell both computer equipment and ‘enhanced services’ which embodied data processing. Computer hardware and software systemsplay a major part in our strategy to provide integrated communications based office automation systems’. unregulated. representing about 75% of AT&T’s total assets. long-distance supplier MCI. 9) stated that ‘one of the most significant events of 1984was our entry into the general purpose computer business.T. .. 2) that ‘.

NCR stated its preference to remain independent but told AT&T that if it were ever under attack from another company. At that time. 1991a). Honeywell with Bull.with lossesof between $100 million and $300 million on salesof $1.Analysts speculated that AT&T chose to expand its investment in order to savefacefor signing the consent decreeas well as for its subsequentpublic confirmations of the divestiture-related strategy and its significant investment in computer technology (Noll. 1990).5 billion for 1990alone (Keller and Wilke. all three post-divestiture CEOs made major public commitments to the computer industry as part of the justification for and strategy after signing the consent decree.356 T Ly. In addition. (UNISYS). 1991). . 1990.AT&T’s managementdid not deny the unprofitable nature of its computer operations. Results for its computer operations are not disclosed separately.Having tried other approaches. and IBM’s 1984 purchase of Rolm) by a management with limited competitive experience entering a highly competitive.Thus. Hewlett-Packard with Apollo Computer. ‘This is according to our December 1991 conversation with Robert C. Burroughs with Sperry Corp. NCR. NCR was also stronger than AT&T in networking. 1990). AT&T experienceddifficulty in achieving the benefits foreseenfrom the divestiture. 1991.’ AT&T approached NCR again seeking a merger agreement in June 1989 and was again rebuffed (Davis. This decision was made despite the consistently dismal history of computer mergers (e.Management elected to increase its commitment to the business. AT&T considered NCR an appropriate acquisition target for several reasons: a) NCR and AT&T had compatible product lines and a similar philosophy about open computer systems using the UNIX operating system. AT&T would be its favored ‘white knight’.g. AT&T first approached NCR as an acquisition candidate in July 1988. In 1990. AT&T’s acquisition candidate.Sloan.Davis. but the financial pressestimated that AT&T’s computer operations lost at least $2 billion between 1984and 1990. Holder. NCR’s stock price was at a three-year low just prior to the bid and NCR had just introduced a new line of computers in an attempt to improve its lackluster performance. L. rapidly changing industry.. AT&T decided to make a major acquisition. Vincent/Journal r$Financial Economics 39 (1995) 353 37X outlet for the technological advances generated by Bell Labs (Verity and Cory. had experienced recent setbacks. 1992). AT&T had also considered several large candidates for acquisition. with operating income before taxes declining in both 1989 and 1990 and revenues increasing an averageof only 2% in each of those years. AT&T’s management concluded that continuing computer losses dictated either a significant increase in its investment or divestiture of the computer operations (Keller. and their unsuccessfulattempts to bolster computer operations included joint ventures and investments in several high technology companies (Keller and Wilke. 1991).

we focus on the major. 1976) and continuously compounded daily returns for AT&T. as indicated in Table 1. 3. the decision to acquire NCR reflected AT&T’s continued efforts to transform itself from a regulated monopoly to a successfulmarket competitor. especially as compared to some of the Silicon Valley firms which AT&T had considered as merger candidates. Perhaps concerned about its poor reputation in the computer business. Becausethe negotiations extended over a six-month period. merger-related events and calculate abnormal returns in two-day windows consisting of the trading day prior to and the day on which each major merger-related event is reported in the Wall Street Journal (WSJ). d) NCR was a possible and practical acquisition whereas some other candidates such as Hewlett-Packard had impediments to acquisition (e. The next section examines whether investors agreed with AT&T’s strategy to acquire NCR and whether the merger resulted in synergies as reflected by an increase in the combined market values of AT&T and NCR as a result of the announced merger.family trusts). In summary. Total wealth implications In order to assessthe wealth effect of the proposed merger.. encompassing many nonmerger events.T. AT&T went outside to obtain critical mass and management talent.AT&T announced early in the negotiations with NCR that it planned to combine AT&T’s and NCR’s computer businesses under NCR’s senior management team. allowing attribution of any unexpected share price changes to the merger-related announcements. this . Becauseof the short windows. and the S&P 500 Composite Index. Moreover.g. Unable to demonstrate profitability in its own computer operations. Table 1 summarizes the key events and associated abnormal returns. we are reasonably sure that no other events were announced concurrently. L. Shareholder value implications 3. AT&T investors reacted unfavorably to the initial news of the proposed merger and the market responsesto subsequent events were generally negative for AT&T whenever the events implied an increase in the probability of successfulcompletion of the transaction. NCR. we compute abnormal returns for AT&T and NCR using the market model (Fama. Lys. Vincent/Journal of Financial Economics 39 (1995) 353-378 351 b) NCR had a corporate culture compatible with AT&T’s. retaining NCR’s name.1. c) NCR had an international computer marketing presenceand customer base which AT&T lacked.

25) + 44.AT&T’s stock fell $2 per share tc $30.96% (.72% ( + 3.07) + 1.2. L.27) NCR abnormal return (t-statistic) + 12.82) . Lys.47) + 3. AT&l indicated that it would complete a cash transaction i NCR preferred. The board of directors of NCR rejected the AT&T bit.4.7.03) + 2.97% ( + 2.62% ( + 1.37) AT&T made a public bid for NCR at $90 per share o a total of $6.04billion.1.88) + 10.00) + 1.1.75% ( .625per share. 12/3/90 12/3/90 . For multiple event days.0.46% ( + 23.52% ( + 5.18) AT&T commenced a tender offer to purchase all out standing shares of NCR common stock for $90 per sharl in cash.39) .96% ( .1.50in response. Federal Court invalidated NCR’s ESOP.43% ( . NCR shareholders woulc also receive a 140% increase in the dividend.51% ( + 0. The t-statistic is calculated by dividing the abnormal return by its standard error fron the estimation period.80% ( + 1. a qualifiec ESOP. 02/20/9 1 02/21/91 03/10/91 03/19/91 03/27/9 1 .61) + 3.7: to $81.1.53% ( + 6.23% ( + 1. 12/06/90 12/06/90 . AT&T announced that it was prepared to raise its offe to $100 per share if NCR would negotiate a merge agreement. NCR established the SavingsPLUS Plan.91) + 2.1.04% ( + 1. the t-statistic i computed as the sum of the t-statistics for each individual day divided by the square root of the number of days AT&T abnormal return (t-statistic) .1.01) .02 per share regular dividend increase. NCR rejected this offer. adjusted for out-of-sample predictions. NCR’s board unanimously rejected the AT&T offer AT&T increased its bid to $90. AT&T proposed to acquire NCR in a tax-free merger (i stock for stock exchange) worth $85 per share to NCR a premium of 80% over the pre-rumor trading price o NCR stock of $47.25per share.358 T.86% (-1. NCR stock price increased $24.78% ( + 3.41% ( . NCR announced a $1 per share special dividend am $0.2. Vincent/Journal of Financial Economics 39 (1995) 353 37X Table 1 Chronology of major events in the acquisition of NCR by AT&T The ‘report date’ refers to the publication date of the Wall Street Journal in which the event was first reported The abnormal return is calculated for the two-day window consisting of the trading date just before the repor date and the report date. NCR reduced its asking price to $110 per share fron $125 per share.08) .1.46% ( .3.12) + 3.125.11) Report date I l/8/90 Event description Unconfirmed report that AT&T and NCR were discuss ing a combination of their computer businesses.40) + 5. but approved the strategy to enter into negotiations witl AT&T if AT&T offered not less than $125 per share NCR’s shares closed at $86.

29% ( . the proxy states that if AT&T is not able to satisfy the conditions necessary for treatment as a pooling of interests.47) + 120. NCR no longer traded on the NYSE.33) (*) Total for the 20 event days .63) .2.16.48 billion. subject to SEC approval.29% ( + 13. in which case the merger would be converted to a cash election merger with 40% of NCR’s shares exchanged for $110 cash per share and the remaining 60% exchanged for $110 in AT&T stock.00% ( .77% ( + 0.T.32% ( .2.31) .29% ( + 14. This indicated that AT&T had received tacit approval from the SEC to structure the acquisition of NCR as a pooling of interests.1.53) (.70) through 05/07/9 I Total for the 24 event days through 09/l 6191 .26% ( . AT&T issued 184. However.25% ( .5 million shares for the merger. AT&T agreed to buy NCR for $110 per share. Vincent/Journal Table 1 (continued) AT&T abnormal return of Financial Economics 39 (1995) 353-378 359 Report date 04/19/91 (r-statistic) NCR abnormal return (r-statistic) Event description AT&T increased its offer for NCR to $110 per share with no collar or adjustment.0.1. Lys.09) + 0.63% ( .19) 09/13/91 09/19/91 . a total of $7. High and low collars were added to the stock deal so that NCR shareholders would be protected in case of a decline in AT&T’s share price prior to the actual merger date.41) NCR responded that it preferred a cash and stock deal but would negotiate an all-stock transaction if AT&T insisted.33% ( .2. AT&T filed NCR’s proxy statement with the SEC for the shareholders’ meeting to approve the proposed merger. The merger would be tax free and. L. NCR shareholders voted to merge with AT&T. 04/20/9 I .1. Merger between AT&T and NCR completed.96) .34) .81% ( + 3.13.37% ( .73% (*) 1.0. then it will revert to the 40% cash and 60% stock purchase. + accounted for as a pooling of interests.11% ( .1.74) .2. This agreement was for an ah-stock merger unless AT&T could not satisfy itself that an all-stock merger could be accounted for as a pooling of interests. [(*) = oneday return for NCR] 05/06/9 1 08/13/91 .1.29) + 5.

negative reaction was consistent across the different structures that AT&T proposed for the deal (e. the initial merger offer followed by a hostile tender offer).29% by the pre-announcement (October 31.360 T. and acquisition periods.is used to estimate the market model parameters used to compute abnormal returns.29% (t = + 14. The sums of the two-day cumulative abnormal returns (CARS) over the negotiation period (see Fig. 1990 (just prior to the initial rumors of merger talks between AT&T and NCR) to May 7. and modes of payments (cash or exchange of stock).13.2.. negotiation. .47) for AT&T and + 120. 1) of November 1.03) NCR abnormal return (t-statistic) + 113.199O) stock price of $34 and the 1. offer prices (ranging from $85 to $110 per NCR share). . Lys.33% by its pre-announcement (October 31. In contrast. L. These returns imply that (for the proposed terms) investors viewed AT&T’s acquisition of NCR as a negative net present value investment. t. Vincent/Journal of Financial Economics 39 (1995) 353.7 billion.3. The acquisition period is defined as the negotiation period plus the period from the merger agreement announcement date to the actual completion of the merger on 9/19/91 when NCR stopped trading. 10/16/89 to 10/15/90. . The estimation period. computed by multiplying NCR’s abnormal return of 120.g. Estimation.Estimation 10/16/90 1111190 Negotietion Period 05/7/91 9/l 9/91 period I Acquisition Period Fig. 1. NCR shareholders’ wealth increased by $3.-378 Table 1 (continued) AT&T abnormal return (t-statistic) .9 billion for the 20 event days comprising the major events during the negotiation period.17.70) for NCR. These abnormal returns translate to a total wealth loss by AT&T shareholders of $4. 1991 (the date on which the signing of the merger agreement was announced) total . The negotiation period of 1l/1/90 to 5/7/91 commencesjust prior to the first bid by AT&T for NCR and extends through the announcement of the signing of the merger agreement. computed by multiplying AT&T’s abnormal return of 13.62% ( .68) Report date Total for the 25 event days through 09/19/91 Event description 10116/89 .199O)stock .33% (t = .092 billion shares outstanding as of the end of the year.53% ( + 12.

27% translates to an overall wealth gain of $3. 1991. AT&T’s CAR for the six-month period . Our abnormal returns analysis concentrates on the six-month negotiation period rather than the entire ten-month acquisition period (Fig. 3Because the negotiation roughly six times larger statistically insignificant would have to be roughly the 5% level.Therefore. PNS is the closing price of NCR stock on October 31. . the two-day windows capture only the change in the probability of the merger directly attributable to the announcements.74per share lessthe per (NCR) share decreasein AT&T’s market value.74 less $76.$2.14. 1990. Consistent with these computations. 1988) are estimated at between .that is.P&P. Therefore. 1990.9 billiom64..The details of all calculations are shown in Table 2.1 billion for NCR’s shareholders. Desai.28% or . 1) because the negotiation period captures the majority (88.5 million NCR shares outstanding as of December 31. an unlikely period contains numerous nonmerger-related events and because AT&T is than NCR. AT&T’s market price decline implies that investors assessed value of NCR the to AT&T at between $28 and $35 per share. substantially less than NCR’s premerger price of $47.3 billion.$10 billion in total market value in order to be significant at outcome in a $7. the synergies for the negotiation period. on the other hand..T.5 billion acquisition.5 billion and NCR shareholders’ wealth increased by $3. investors may *The market-implied probability of completion is computed as (P .2 billion. experienced a decreasein wealth of approximately $5.25and the 64. AT&T shareholders.. Lys. the implied value to AT&T of each NCR share was $110.5 billion.27% (t = + 15.5 million shares). Vincent/Journal of Financial Economics 39 (1995) 353-378 361 price of $47.8861. or $34. it is not surprising that AT&T’s CAR within that period is at conventional levels.50 . we also expand the analysis to include all trading days within the negotiation period. Indeed. This translates to a per share value of NCR to AT&T of $10.0 billion for the merger-related events as AT&T shareholders’ wealth declined by $6. computed as the price paid by AT&T of $110.3 billion and .87 per share.~ NCR’s CAR of + 103. 1983). Extending the analysis to the entire acquisition period (1 l/1/90 to 9/19/91) results in negative synergies of $3. and Kim.30) for NCR and .9 billion for the major events of the negotiation period translates to $76 per acquired NCR share ($4. For example.32% (t = .47. Investors’ negative response to AT&T’s acquisition of NCR was consistent with AT&T’s poor performance in the computer business. and Ps is the final offer price [($103.’ While mitigating the influence of nonmerger-related events.00) for AT&zT. resulting in CARS of + 103. thus underestimating the aggregate market impact of the announcements (Lewellen and Ferri. or roughly $4. where P is the closing price of NCR stock on May 7. computed as the sum of the changesin shareholder wealth of the target and the bidder (Bradley.I’.6%) of the resolution of uncertainty associated with the merger (Larcker and Lys.74.25)/($110. L. 1987).74 .25) = 0.47. .$1. over the same period.1.). AT&T’s total market value decline of $4.

) .81% 129.459 billion’ .$1.e.664 billionb .03) 113. The (imputed) value to AT&T of each NCR share is calculated as the price per share of NCR that AT&T could have paid without decreasing its own price per share.285 billion $35 per shared .29% ( + 14. for AT&T and NCR during the negotiation and acquisition periods.11% 25.14.34% 124.362 lY Lys.32% ( .) .53% ( + 12.) NCR (t-stat.62% ( .33% ( .For two reasons.47) 120. and shareholder wealth effects.) NCR (t-stat. thereby including the effects of nonmerger-related events. An alternative explanation for the negative market reaction is that the market was responding to the effective announcement that AT&T was not going to exit the computer business.1. we believe that the negative response was due to the announced acquisition of NCR.and risk-adjusted) returns (CARS). The net shareholder wealth effect (the sum of the change in wealth of AT&T and NCR) measures the (negative) synergies for the merger. The wealth effects for the entire period are computed using the cumulative abnormal returns for all trading days within the period..$6.51) 111. Negotiation period November 1.$4.70) . market.13.30) .50% 30.3. AT&T had previously pursued several potential merger partners and had initiated joint ventures with companies including Sun Microsystems and Olivetti.$3.542 billione’ + $3. 1991 AT&T (t-stat. First. continuously compounded (neither market-nor risk-adjusted) returns. if the negative market responses were due to the announcement that AT&T was remaining in the Table 2 Cumulative abnormal (i. L.17.03% 16. The continuously compounded returns are provided for comparison purposes so it is clear that the useof the market model is not the sole source of the results.2. however.24) Continuously compounded (nonmarket-adjusted) AT&T NCR S&P 500 Merger-related events only 10. 1990 to September 19.0.47% AT&T wealth loss NCR wealth gain Negative synergies’ Value to AT&T of NCR share .00) 103. implying that the prior probability that AT&T intended to exit the computing business was low. The wealth effectsfor the merger-related events are computed using the sum of the abnormal returns for the events days given in Table I.949 billion” + $3. Vincent/Journal of’Financial Economics 39 (1995) 353 37X have believed that AT&T would dissipate its investment in NCR just as it had previous computer investments.49% ( .27% ( + 15.68) Cumulative abnormal returns (all trading days) AT&T (t-stat.10.083 billion $10 per shares . Second.35% ( + 4. 1991 Cumulative abnormal returns (merger-related events only) Acquisition period November 1. 1990 to May 7.

00 per share 10/31/90.3 17 billion” + $3.27%CAR x 64. $110.32%CAR x 1.895 billion” + $3.48 million shares of NCR).($4. ‘111.25 per share 10/31/90.2. 1990 to September 19.00 per share 1013l/90. k.17. Lys. 1991 . 1990 to May 7.14.then we would expect the market reaction to be immediately negative and not spread out over additional events in the acquisition period that offered no additional information about a change in strategy.74 .($5.392 billion’ .48 million shares of NCR).949 billion + 64. Vincent/Journal Table 2 (continued) of Financial Economics 39 (1995) 353-378 363 Negotiation period November 1. NCR’s 1991 . AT&T discloses them in its quarterly earnings announcements.146 billion’ .092 million shares outstanding as of 12/31/90 x $34. however. 1991 Entire period (a/l trading days) AT&T wealth loss NCR wealth gain Negative synergies’ Value to AT&T of NCR share .$0.74 .25 per share 10/3 l/90.092 million shares outstanding as of 12/31/90x $34.NCR’s last full year financials for 1990 reported $6.317 billion + 64. 3.3 billion in sales and $369 million in net income.29%CAR x 64.092 million shares outstanding as of 12/31/90x $34. Was the market’s assessment correct? Although results for AT&T’s computer business are not broken out separately in its financial statements.49%CAR x 1.$3.($6.48 million shares outstanding as of 12/31/90x$47.10.25 per share 1o/3 I /90. Because of the consolidation of NCR and AT&T’s previous computer operations. the post-merger results should be greater because they incorporate more than just NCR’s assets.62%CAR x 1. post-merger results are not directly comparable to NCR’s pre-merger results.895 billion t 64.503 billion $50 per share” price as of price as of a .($3.74 . ‘Wealth loss of AT&T plus wealth gain of NCR. price as of price as of price as of price as of price as of price as of computer business.48 million shares outstanding as of 12/31/90x $47.$2.T.092 million shares outstanding as of 12/31/90x $34.74 . “$110.00 per share 10/31/90. YS110.$5. L.25 per share 10/31/90.00 per share 10/31/90.48 million shares outstanding as of 12/31/90x $47.13.35%CAR x 64.171 billion $28 per share’ Acquisition period November 1. ‘113. b120.53%CARx64. d$l 10.48 million shares of NCR).48 million shares outstanding as of 12/31/90x $47. e .542 billion + 64. h. ‘103.33%CAR x 1.48 million shares of NCR).

Finally. we estimate the incremental costs and discuss the potential benefits from AT&T’s obtaining permission to account for this transaction using pooling-of-interests accounting. NCR CEO Exley. Lys. . investors correctly perceived AT&T’s implementation of the strategy as valuedestroying. In this section. The 1993 results indicated $7. as promised. and the history of unsuccessful computer mergers. especially when considered relative to a $7. This assessmentof the market’s prescience with respect to the acquisition of NCR is conducted with the benefit of hindsight. with actual sales of $6. The market has not always been correct in its evaluation of acquisition proposals. based on performance to date.AT&T has thus not maintained its announced strategy to retain NCR’s name. when the merger was completed and former NCR President Williamson left AT&T during 1993.1 billion in sales and $288 million in operating income. reputation. In addition. and management following the merger. AT&T’s strategy was consistent with trends in the industry to integrate voice and data processing capabilities. However. The costs and benefits of pooling AT&T made pooling-of-interests accounting one of the central issues of the merger with NCR. In early 1994. L. Thus far. However.62 billion in salesand $386 million in operating income. These conditions do not imply that ex ante AT&T’s overall strategy for merging telecommunications with computers was incorrect. including $190 million of restructuring charges.5 billion investment.364 T. 1994). 1991b). The first quarter 1994 operating loss of $61 million included restructuring charges of $120 million. its lack of success with its own computer operations.In summary.AT&T reported 1992computer results of $7. the evidence to date is not encouraging. in June 1994 the AT&T executive vice president and chief of its multimedia products and servicesgroup who had launched all three of AT&T’s attempts to acquire NCR left AT&T for another position (Rundle and Keller. Vincent/Journal @Financial Economics 39 (1995) 353-378 results were ‘materially below’ projections made to AT&T of $6. 4. indications that this acquisition would be difficult at best were provided by AT&T’s lack of experience in a competitive environment. had departed. including a $182 million charge due to merger expenses(Keller.3 billion in salesand a net operating loss of $99 million.500 employees during 1994. while one may argue that sufficient time has not passedfor the final assessmentto be made of AT&T’s acquisition of NCR. in late 1993 NCR announced plans to reduce its work force by 15% or 7. AT&T changed the name from NCR to AT&T Global Information Solutions (GIS).3 billion and operating income of $103 million. operating results have not been impressive compared to NCR’s historical performance. with 36 years of experience in the computing business.

although cash flows would be identical. Item 4 violated another pooling requirement prohibiting the selective payment of cash to some NCR shareholders but not to others.69 billion in this case. Items l-3 violated the prohibition against any changesin equity interests. In February 1991. and 4) the cash-out provision in the NCR stock option plan.NCR established a qualified ESOP with control of approximately 8% of NCR’s voting shares and declared a special cash dividend of $1 per share at the same time. preceded the merger negotiations. with the difference between the market value paid and the book value of the acquired net assets.1.) Two additional impediments to pooling.or $5. the four impediments to AT&T’s obtaining SEC permission to use pooling-of-interests accounting were: 1) NCR’s share repurchases in 1989 and 1990. The required method is dictated by the structure of the transaction and the history of the two companies. 3) payment of the $1 special dividend by NCR. Both of these actions qualified as changesin equity interest.T. Lys.to be amortized over the life of the acquired assets. NCR’s use of accounting issues in its acquisition defenseis unique.4 GAAP prohibits any change in equity interests of the voting common stock of either combining entity within two years of a combination accounted for as a pooling. Requirementsfor pooling Generally accepted accounting principles (GAAP) provide two methods for recording business combinations: purchase and pooling-of-interests.As a result. requested the SEC’s concurrence on November 29. The purchase method uses the market value of the consideration paid.199Owith the reissuanceof treasury stock to cure the taint of repurchased sharesso that the proposed businesscombination could Vash flows could differ due to differential tax treatment. AT&T’s accounting firm. L. accounting net income in this case would be lower under purchase accounting. In summary.1990. Coopers & Lybrand (C&L). (To the best of our knowledge. NCR’s share repurchases in 1989 and 1990 and the cash-out provision of NCR’s stock option plan. all offers made by AT&T were structured as tax-free acquisitions of stock (IRC Sec. 2) the establishment of NCR’s ESOP. NCR used this requirement as part of its defense against AT&T during the takeover battle. regardless of whether the SEC allowed pooling. The pooling method usesthe book value of net assetsof the target. 368). . with the exception of the all-cash offer made on December 6. Vincent/Journal of Financial Economics 39 (1995) 353-378 365 4. thus precluding the use of pooling for the business combination. but AT&T believed there were precedents for reversing them. BecauseAT&T had made clear its strong preferencefor pooling early in the negotiations. However.

1991 internal SEC memorandum: . Vincent/Journal of Financial Economics 39 (1995) 353.366 T. AT&T increased the price of the deal from $110 to $110. The Chief Accountant of the SEC responded on December 6. the SEC staff. According to a July 5. This item was discussedin a meeting of representatives from both AT&T and NCR with SEC staff on May 14.74 so that NCR shareholders were not hurt by the cancellation of the two normal quarterly dividends of $0. the SEC required the shares to be reissued prior to the merger. the staff has previously allowed registrants who have had an alteration of an equity interest to ‘cure’ it by unwinding the transaction within a short period of time after it occurs. Had this transaction not used the pooling method. However. The Court’s invalidation of the ESOP on March 19. . while acknowledging that NCR deliberately violated the requirements for pooling during the takeover activities. stating that ‘the pooling issue is fundamental to the proposed transaction’.000 additional shares were subject to the cash-out provision. 37X be accounted for using pooling. Finally. 1991internal SEC memorandum stated that both the SEC and the Financial Accounting Standards Board concluded that the cash-out provision violated pooling provi- . Therefore. On February 25. NCR’s stock option plan provided that during a change in control. . The SEC staff orally advised C&L on February 26 that if the court declared the ESOP invalid. A July 5. However.37 (a total of $48 million). 1991 eliminated that impediment to pooling. as a result of AT&T’s lawsuit.4 million. an unlikely outcome in a hostile takeover. resulting in the transaction putting the entity in the sameposition it would have been prior to the alteration. the SEC staff determined the dividend would be considered to be in contemplation of the business combination and a violation of the pooling rules. There were approximately one milhon such options outstanding with an aggregate value of $63. NCR’s cooperation was necessary to accomplish the SEC’s requirements.C&L wrote to the SEC regarding the potential effect on pooling of NCR’s $1 special dividend (approved February 20). agreed to permit pooling if NCR would cure the special dividend by forgoing the normal secondand third-quarter dividends. 336. all outstanding executive stock options would immediately vest and the holders would be entitled to receive the difference between the fair market value of the stock and the price of the option in cash. The staff did not accept the argument that the $65 million dividend was immaterial. L. and such reissuance would be impossible without the co operation of NCR. 1990 that the SEC staff would not object to pooling under the proposed circumstances. there would have been no reason to reissue these shares and incur the associated costs of a securities offering. Lys. Again. To gain this cooperation. 1991. then the ability of AT&T and NCR to account for the transaction as a pooling would not be impaired by the attempted establishment of the ESOP.

an immediate profit to Capital Group of $50.. Lys. rather than the purchase method. it would be very unlikely that AT&T could get pooling treatment’. The incremental costs of pooling On August 9.. SEC staff informed AT&T and NCR that the option provisions would have to be amended so that NCR option holders would receive equivalent AT&T options or exchange their options for AT&T shares.e. Similarly (Cowan. (Our investigation of the placement of the 6.3 million and an offsetting cost to AT&T. As Robert Willens. indicating the SEC’s tacit approval of the terms outlined in the proxy. illustrating the bargaining power afforded NCR by AT&T’s determination to achieve pooling treatment.3 .3 million shares of NCR stock would be exchanged for $110. But NCR took steps(i. noted (Sloan. this merger demonstrates that it is possible for a cooperating target retroactively to reverse its own (hostile) actions in order to qualify a transaction for pooling.3 million NCR shares prior to the completion of the merger.37 per share and the special $1 dividend would represent the total ‘normal’ dividend for the year. to withhold further dividend payments in 1991 so that the combination of the regular February dividend payment of $0.3 million shares to be reissued prior to the acquisition to satisfy one of the conditions for pooling. The above discussion also indicates that a literal interpretation of SEC requirements precluded AT&T from using the pooling-of-interests accounting method. AT&T has indicated that it would prefer to account for the proposed acquisition [of NCR] under the so-called pooling method. AT&T arranged on August 29 for NCR to place the 6. Although three investment banks were named to comanage the issue. This private placement was at a 5% discount to the then market price of NCR shares and permitted Capital Group to withdraw from the purchase if the merger was not approved by NCR shareholders. Thus. 1991): ‘All along. On that sameday. an accounting and tax expert with Lehman Brothers. Inc. Vincent/Journal of Financial Economics 39 (1995) 353-378 361 sions. NCR agreed to reissue 6. Upon approval of the merger by NCR shareholders. after approval by NCR shareholders at a meeting scheduled for September 13. The NCR offering was structured to sell the shares on the eve of the merger. However.2. the 6. a California money manager. the ESOP and the special dividend) that would make it hard for AT&T to use the pooling method. 1991b):‘If the [$l special] dividend is paid. for $102. and to convert automatically from NCR to AT&T stock under the terms of the merger agreement.75 per share. NCR’s cooperation was also necessary to accomplish this requirement for pooling. AT&T filed a registration for the shares it would issue in the stock swap to acquire NCR and NCR filed a registration statement for the 6. and to amend the cash-out provision of the stock option plan. L.3 million shares with Capital Group.T. 4.74 worth of AT&T stock. 1991.the SEC releasedNCR’s proxy statement for shareholder approval of the merger with AT&T.

Indeed. this amount was paid even though AT&T had achieved effective control of NCR when shareholders tendered 70% of their sharesin responseto AT&T’s $90 per share offer in February 1991.vs. . the SEC had not indicated its position on either the snecial dividend or the cash-out provision of the stock option plan at the time the merger agreement was signed. Because of the remaining uncertainty. L. plus another $5 a share if AT&T pays in stock and can treat the acquisition as a pooling of interests. VincentJJournal cf Financial Economies 39 (1995) 353--37X million NCR shares did not reveal the existence of any compensating transactions between Capital Group and either NCR or AT&T.e. AT&T needed the cooperation of its hostile target to reverse actions NCR had taken which would prevent pooling. AT&T paid a confirmed $50 million for the reissuance of NCR’s treasury stock and was willing to pay another estimated $450 million to gain NCR’s cooperation in order to account for the transaction as a pooling rather than a purchase.’ (Smith. At least part of this increase in price was offered to obtain the cooperation of NCR’s management. AT&T then captured 78% of the votes cast at a March 28 special shareholders’ meeting. would not have been friendly and would not have qualified for pooling. AT&T indicated in the May merger agreement and the final proxy statement that if pooling were not allowed. However. avoiding certain accounting charges. In summary. AT&T’s preference for pooling was strong.) The indirect costs of gaining SEC approval for pooling were even higher. given the 65 million shares outstanding) if NCR would cooperate in obtaining the SEC’s approval for pooling: ‘AT&T has indicated it is prepared to pay as much as $102 a share in cash to gain a friendly merger agreement. All of this was in the face of uncertainty as to whether the SEC would permit pooling. Furthermore. the deal.368 T. including both the CEO and the President. it would shift to a 60% stock and 40% cash deal for the purchase. Although NCR’s share repurchases and the ESOP had been eliminated as impediments to pooling. 1991). AT&T’s Robert C. as demonstrated by the costs incurred to qualify for pooling. 1991. but finally agreed to be acquired for $110 and to work with AT&T in seeking approval for pooling. NCR had rejected AT&T’s offer of $100 which was contingent on negotiating a friendly deal. Nonetheless. under these conditions. i. the financial press reported that AT&T offered to pay NCR an additional $55$7 per share ($325-$450 million in total. AT&T signed the merger agreement and indicated that it would consummate the transaction. L. even if the SEC disallowed pooling. at one point during the negotiations. As mentioned above. Holder confirmed this willingness to pay for pooling in our discussions on December 6.. sufficient to replace immediately four of the twelve directors.

Lufkin & Jenrette Securities Corp. an analyst at Donaldson. AT&T was concerned about explaining a potential deficit in retained earnings under purchase accounting. 4. AT&T amortized goodwill over periods ranging from lo-15 years (AT&T’s 1990 Annual Report. Shareholder communications AT&T. Why was AT&T intent on achieving pooling treatment? Although the choice between pooling and purchase accounting has no direct cash flow implications.90 this year (i. 1991b)..’ said Joel Gross. it is probable that the goodwill would have been amortized over a maximum of ten years. Second. ‘The street has AT&T earning $2. amortization of purchased goodwill over less than ten years is typically appropriate. The SO. see comments by Robert Willens of Lehman Brothers in which he estimates that a ten-year amortization period would be required (Sloan.T.75 if pooling isn’t allowed. 28). Lys.An all-equity purchase transaction would result in an EPS of $1. the effects on the combined financial statements are significant. p. Also.3.50 or cut it to $2. AT&T’s assistant general counsel stated to us in a telephone ‘The SEC Staff Training Manual states that for high technology industries. L.97. was concerned about its shareholders’ reactions to two aspects of the financial reporting results under purchase accounting. purchase accounting would decreaseAT&T’s EPS by more than 20%. . Because of the nature of NCR’s business and its rapidly changing technology. AT&T expressed concern that shareholders would misinterpret the decreased earnings under purchase accounting as decreased cash flow. 1991a) Table 3 illustrates the effect on AT&T’s 1990EPS of the accounting alternatives for the acquisition of NCR. 1991).3. The following quote is representative of the concern expressedin the financial press over the negative impact on AT&T’s EPS of the merger with NCR if the purchase method of accounting were used: ’ ‘If AT&T does not get permission from the SEC to use the pooling accounting treatment. AT&T’s preferred pooling-of-interests method results in an EPS of $2.but pooling could boost that to between $3 and $3.1. resulting in a lower share price. Vincent/Journal of Financial Economics 39 (1995) 353-378 369 4.’ (Keller. with more than 75% of its stock held by individual investors. As illustrated in table 3.42.45 share difference between an all-equity pooling and per an all-equity purchase is due to the amortization of goodwill. First. the resulting good will could hurt annual earnings to the tune of 5% a year. resulting in a $569 million annual decreasein earnings.5 We next discuss three nonmutually-exclusive explanations for AT&T’s willingness to pay such a premium for pooling.e.

000. goodwill is amortized over ten years.104.000 1.06 “This scenario resulted in the lowest EPS due to the greater dilution caused by the new shares. see Wilson.285. 1991. The financial press echoed this preoccupation with EPS as illustrated in the following quote. In addition to concern over individual shareholders’ reactions to the decreased EPS.792. Other assumptions are that the cash portion of any scenario is financed with debt at an interest rate of 6%. Using AT&T’s P/E ratio of 15. accountants say.285. _____.000.000 $3.000 $2.000.ooo. making it impossible to construct separate pro forma financials for 1991. This scenario could have been replicated with any of the partial cash scenarios if AT&T issued new shares to retire the debt. the additional $5-$7 per share reportedly offered by AT&T in exchange for pooling roughly corresponds to the earnings increase of $0.000 Number of shares 1. if AT&T shifts to a pooling from a cash offer. ‘The marriage would be a lot happier and so would Wall Street.Net income AT&T EPS for 1990 (without NCR) Pooling-of-interests with 100% stock Purchase with 40% cash and 60% stock Purchase with 100% stocka Purchase with 100% cashb $2.OOQOOO l.735.51 52.. VincentJJournal qf Financial Economics 39 (1995) 353 378 Table 3 Scenarios depicting possible values of AT&T’s EPS for the year of the acquisition assuming that the acquisition took place on January 1.000. The stock-for-stock exchange ratio used is the actual one of 2. 1991). and net income is reduced for the after-tax cost ofdebt using the federal statutory tax rate of 34% which approximates AT&T’s actual 1990 rate. --. the results of AT&T and NCR were combined.416.207. interview that AT&T believes investors mechanically capitalize its accounting earnings.O89. 1990 This simplifying assumption is necessary because once the merger was consummated on September 19. These concerns were expressedto us in telephone interviews with spokesmen for AT&T.OOG EPS $2. The maneuver also could allow AT&T to pay a slightly higher price.97 $2. according to accountants. Lys.00 $1.238. L. ‘This transaction would not have been tax-exempt to either shareholders or the corporation and therefore was not a likely alternative.370 T. suggesting that AT&T was justified in paying a premium for pooling: ‘AT&T could save hundreds of millions of dollars in reported profits with the flick of a pen by changing its hostile $6.000 1.000 1.000 %2.000. AT&T believed that in subsequent years even financial analysts would forget the composition of earnings and penalize AT&T’s stock price for the lower earnings.000 $2. .45 per share achievable with pooling (for a description of similar executive behavior. It is included for purposes of comparison only. The potential savings would come from avoiding a tricky accounting item called good will.OOO.42 $ billion cash offer for NCR Corp. into a friendly stock swap. which AT&T could dodge if it transformed the battle into a friendly deal.839 shares of AT&T for each share of NCR.535.’ says Janet Pegg.

AT&T is a New York corporation and while New York’s BusinessCorporation Law does not prohibit payment of dividends that exceedretained earnings. compared to pooling. purchase accounting would result in a lower. AT&T’s concerns about the balance of retained earnings may have also affected its accounting decision. it does require special written notice to shareholders when such excessive payment is made (McKinney’s.under a pooling’. . AT&T indicated it would change the structure of the acquisition to 40% cash and 60% stock.5 billion in the first quarter of 1993 to recognize other post-employment benefits rather than spreading this charge over the allowable maximum of 20 years [Statement of Financial Accounting Standard (SFAS) # 1061. However. VincentJJournal of Financial Economics 39 (1995) 353-378 371 a certified public accountant who is an analyst and vice president at Bear Stearns & Co.01 per share since 1984. while avoiding the annual goodwill amortization expense of $569 million. increasing the amount of debt outstanding even though AT&T did not want to compromise its flexibility for making additional investments by taking on more debt. and possibly negative. AT&T intended to do a tax-deferred (IRC Sec. AT&T maintained to the SEC staff that the decrease in earnings caused by purchase accounting could affect its accessto equity and debt capital in the future becauseof investors’ and creditors’ perceptions. In any case.52 per share in dividends and earned $8.Dividend payments in excessof accumulated earnings and profits (computed for tax purposes) are not taxable to the recipient at the time of distribution but reduce the basis of the stock [IRC Sections 301(c) and 316(a)] and would be a benefit to the tax-paying shareholders of AT&T. concerns with retained earnings as an explanation for pooling appear inconsistent with AT&T’s announcement in November 1991 that it would take a one-time charge of between $5. Lys. so these benefits would not be available to shareholders.5 and $7.T. 1986).and NCR shareholders wouldn’t be hit by taxes . balance of retained earnings. This one-time write-off in combination with the amortization of purchased goodwill from the NCR acquisition would likely result in negative retained earnings for AT&T by the end of 1993. Thus.AT&T may have worried that dividend payments out of reported contributed capital would alarm its ‘unsophisticated individual investors.thus depleting its retained earnings by the difference and leaving a balance of $4. L.199l memorandum to the SEC staff indicating that if purchase accounting were required. ‘AT&T could boost its offer . AT&T had paid $8. then AT&T management would be ‘compelled’ to mitigate the double impact on EPS of the increase in number of shares for a pure equity transaction and the decrease in earnings due to goodwill amortization. On the surface.5 billion. Thus. this balance would be increased by NCR’s retained earnings of $1. 1991) Further evidence of AT&T’s concern occurs in a May 17. Under pooling. 368) reorganization even if purchase accounting were used.’ (Cowan.2 billion in retained earnings as of 12/31/90.

Dechow and Sloan. the write-off of the post-employment benefits and the avoidance of purchase accounting are consistent with AT&T’s concerns about the importance of EPS and its belief that neither investors nor financial and credit analysts remember the composition of earnings from year to year. we estimate the association between executive compensation and AT&T’s earnings to assess the potential magnitude of the accounting choice on total cash compensation by regressingcontemporaneous total cash compensation for both the CEO and the top officers as a group on AT&T’s EPS for the years 1984-1990 (Healy. or any other plan details. 1986). Vincent/Journal of Financial Economics 39 (1995) 353--378 However. when making that decision. L. avoids annual charges against earnings that would have occurred under the alternative method. 1985. Therefore. AT&T’s adoption of SFAS 106 in one step. 1987). 4. are provided in public documents for the three incentive compensation plans in effect at the time of the acquisition. leaving AT&T with a preference for avoiding carrying over deductions.Therefore. Watts and Zimmerman.and by $508. and Palepu.8% for officers as a group (based on their 1990 total cash compensation of . both Moody’s Industrial Manual and Standard & Poor’s Corporation Bond Guide indicated no restrictive debt covenants for any of AT&T’s other outstanding issues. 1986.g. The slope coefficients are statistically significant at the 10% level for the CEO and at the 5% level for the executive officers as a group. 4. Lys. our estimates imply that the $0. Thus. AT&T was already assured that the SEC would allow pooling. debt covenants cannot provide an explanation for AT&T’s preference for pooling and financial structure. Holthausen and Leftwich. Kang. Incentive compensation (bonus) plans Another possible explanation for AT&T’s preference for pooling is evidence that accounting-based bonus plans influence management decisions (Healy. Assuming that the Board does not adjust cash bonuses for the effect of goodwill amortization. 1991). 1979. Likewise. We examined 1990 AT&T indentures with Bank of New York and Chemical Bank.or working capital) to define restrictions (Smith and Warner.3.3. neither of which had any restrictive covenants that would have been affected by the pooling/purchase decision. Unfortunately.1% (using the CEO’s 1990 cash compensation of $2. no specifics of the relation between compensation and accounting numbers such as earnings or EPS.000). Bond covenants Typically.312 T. however. total assets.45 reduction in EPS resulting from the amortization of goodwill in 1991 would have reduced the CEO’s cash compensation by $63.net income.2.212 or 3. management may select accounting procedures to avoid potentially binding covenants and thus influence both firm value and the distribution of that value between bondholders and shareholders..021. bond covenants use financial accounting numbers (e.3.140 or 3. Consequently.

8 million (including 1.000).. the present value of such decreases compensain tion would total $427. the (pre-tax) net wealth effect of the accounting choice is the difference between the present value of the increase in cash compensation and the offsetting decrease in stock price.623.092 million common shares outstanding as of December 31.468 ($0. 1990. we compare the present value of the cash compensation effect to the reduction in value of the stock and options held by the CEO and the corporate officers caused by the estimated maximum $500 million incremental payment for pooling.6 The decreasewould persist for the ten-year amortization period.0 .445for Allen ($0.T. L.34)) along with our estimated cost of obtaining NCR cooperation for pooling of $500 million. The largest individual shareholder was Robert E. Allen.530.46 x 1.. the net benefits would be $413.e. In summary.e.530.$140.414options. an average of $131.2 million stock options) or 0.530x (1.092 million shares). translates to a value loss of $140. albeit subjectively.468) for all officers.667 on average to all officers). which. 1. Consequently.153 per person in favor of pooling. i. with 65. by avoiding a decline % a private discussion.316 shares) and $811.46 per share ($500 million + 1. To evaluate the wealth implications of the accounting method choice. the estimated benefits to the CEO and all officers would be even greater (i.212per year for ten years discounted at 10%) for the CEO (age 55 in April 1991) and $3.0.445) for Allen and $2.. This computation is based on the assumption of no direct stock price benefits from pooling.$811. If the costs of pooling were less than $500 million.200 to the CEO and $167. while there is evidence that there may have been some compensation-related incentives to manage EPS.434. the more convincing reason for AT&T management’s preference for pooling is their belief that they can manage investors’ and analysts’ perceptions via reported EPS. Assuming a corporate marginal tax rate of 34%. translates into a decreaseof AT&T’s stock price by about $0. AT&T’s proxy statement indicates that of the 1.46 x 305. at a cost of $50 million. Lys.434. These net effects are $286.764.the magnitude of these net benefits relative to total cash compensation and the wealth of these individuals appears. the after-tax present value of the incremental compensation paid of $2.062($3. in turn. Assuming a 10% discount rate.e.245 .162% were beneficially owned by directors and officers.434.267 million ($3.530for all officers as a group. Although we cannot conclude whether the magnitude of these net benefits of pooling to individual officers and directors is sufficiently large to justify expending between $50 and $500 million of corporate assets.902 sharesand 239. the present value of $63. Vincent/Journal of Financial Economics 39 (I 995) 353-378 313 $13. to be small.063 shares) for all officers as a group. Chairman and CEO.245(i. a compensation consultant indicated to us that AT&T’s short-term bonus plan is based on earnings before extraordinary items (thus including the amortization of goodwill).800 ($427. .

a $50 million additional payment is material.De Bondt and Thaler. AT&T’s argument that professional securities and credit analysts as well as investors are unable to decomposeearnings under purchase accounting or to see through the window-dressing effects of pooling accounting conflicts with the notion of market efficiency. would be helpful to assesswhether the expected benefits in the form of shareholder understanding outweigh the costs. One can also argue whether. Such bad mergers result from managerial objectives that are not generally consistent with maximizing shareholder wealth. and Mandelker. In this section. However. no such benchmark is publicly available. In the Merck. AT&T’s strong preference for pooling.374 T. ignoring the market’s assessment? In Section 3. p.. makes the additional amount paid for window dressing even more curious. resulting in a wealth loss of $6. Shleifer. unfortunately. The issue then becomes whether an expenditure of $500 million (less than $0. This view is consistent with mounting evidence on market inefficiency (e. 5. Some benchmark.5 billion. Lys. Why did AT&T pursue this acquisition.g. in a transaction of $7. we discuss three possible reasons for AT&T’s persistence in acquiring NCR. and Vishny study. 1978). and Vishny’s (1990. AT&T has not considered even $10 million an immaterial amount in other contexts. Shleifer. Vincent (1995) investigates whether investors value mergers similarly regardless of the accounting treatment and reports results consistent with the efficient markets hypothesis.05 per share) can be justified on the grounds of improving communications with some shareholders since there are no direct cash flow benefits. Vincent/Journal of‘ Financial Economics 39 (1995) 353 378 in EPS due to purchase accounting. bidders with a three- . AT&T’s pre-merger performance was consistent with Merck.However.50 per share) or even $50 million (less than $0. we document that AT&T pursued this acquisition despite the market’s consistently negative assessment of the investment. 33) assessmentthat ‘bad managers might make bad mergers just because they are bad managers’. 1985). Section 4 documents that AT&T’s insistence on the pooling-of-interests treatment may have contributed $500 million to this wealth loss. combined with its intention to complete the deal regardless of the accounting method used.More recently. Justification would imply that the benefits from improving communications with some shareholders in the form of higher EPS outweighed the costs to these as well as to all other shareholders. First. L.5 billion to AT&T shareholders. For example. such as the shareholders’ relations budget.AT&T refinanced more than $2 billion in debt in order to save $10 million in annual interest (or roughly $50 million on a pre-tax net present value basis). research directly investigating the consequencesof purchase accounting on stock prices finds no evidence of inefficiencies (Hong. Absent evidence to the contrary. Kaplan. in 1992.

02% in the four days ( .AT&T management’s disregard of the market’s responseis consistent with management overconfidence (or hubris. AT&T’s change in equity value. calculated as the change in the bidder’s equity in the four-day window ( . environmental.093 billion). Allen’s public airing of his strategic vision to make AT&T a significant player in the computer business may have intensified this commitment to proceed. Furthermore. and structural pressuresto continue the course. and exiting the business was not possible under these conditions. justifying ignoring its response.2 to + 1) around the initial bid announcement in the WSJ divided by the final acquisition price of the target’s equity.365 billion/$7.T. . (iv) the action has important ramifications for the individual initiating the action. Salancik (1977) and Keisler (1971) argue that individuals are more likely to become bound to their prior actions when: (i) the action taken is explicit and unambiguous. Vincent/Journal of Financial Economics 39 (1995) 353-378 375 year income growth rate below their industry average are defined as badly managed and experience an average stock market reaction of . seeRoll. AT&T felt compelled to make its investment in computers pay off. structural factors encouraged commitment to the chosen course.$1. AT&T’s Holder maintained that AT&T could have justified paying even more than $110 per share based on this information.24% ( . and Vishny’s result. there are powerful psychological. The environmental and historical pressures were also significant becauseof the signing of the consent decreeby which AT&T gave up its regulated monopoly status in exchange for the opportunity to pursue the computer business.Part of the justification for AT&T’s confidence was its belief that it had been given significant private information by NCR early in the negotiations under a nondisclosure agreement. 1986). Second.2 to + 1) around the announcement of the initial bid. using this calculation and December 3. or well below Merck. regardless of subsequent information to the contrary. Furthermore. 1990 as the date of the initial bid. Research has shown that persistence is likely to occur in projects when persistence is seen as costly but less catastrophic than withdrawing (Ross and ‘We thank Margaret Neale for helpful discussions on this topic. was .5. (iii) the action was taken freely. and (v) the action is public. Lys. the market has not been infallible in its assessment of acquisitions. In addition.the argument is that once a decision maker takes action. CEO Allen’s decision to acquire NCR satisfied most of these conditions.19. L. Shleifer. The criticism by the financial press and DOJ’s abandoning the IBM suit increased the pressure to justify this tradeoff. A third explanation for AT&T management’spersistencein acquiring NCR is provided by the results of behavioral research into escalation of commitments7 In essence. (ii) the action is not easily reversed.

Or perhaps. whether they be hubris. and the mounting losses of its computer operations to initiate and complete the NCR acquisition. in the face of negative feedback. 6.a cue to redirect efforts within a project. Our analysis indicates a resulting decrease in AT&T shareholders’ wealth of as much as $6. Vincent/Journal of’Financial Economics 39 (1995) 353-378 Staw.or at least provides further opportunities for it to be proven correct. AT&T may have felt pressured by the consent decree. 226) suggest: ‘The decision maker may. even by court decree as in this case (Thaler. Further commitment of resources somehow ‘justifies’ the initial decision (Staw. further explaining AT&T’s persistence. 1976). it appears that AT&T wanted to redeem itself for the 1982 decision to divest its operating companies. Finally. those of large-sample studies: managers of poorly performing corporations make bad mergers. p. AT&T disregarded the negative signals from the market and relied on its internal valuations. but stronger than. bad management. 1989). rather than a messageto be heeded. AT&T could have continued to pursue its strategy of combining .’ AT&T’s failure in the computer businessand its decision to increase its commitment rather than exit the business are consistent with this explanation. Based on history. 1980).376 T. rather than abandon it (Connelly. feel the need to reaffirm the wisdom of the time and money already sunk in the project. the decision maker will rationalize away the negative feedback as a whim of the environment .In explaining this escalation of commitment. However.its own numerous public statements touting its computer strategy after the divestiture. research suggests that the endowment effect can exist for property rights acquired by a variety of means. and Thaler (1990) for a discussion of the endowment effect on organizations. Lys. or escalation of commitments. The decision maker may also treat the negative feedback as simply a learning experience . Northcraft and Wolf (1984. 1978). Knetsch.] Thus. implementing this right was integral and compelling. as well as to confirm its many public statements of commitment to the computer business and to justify its significant investment in computers. from an organizational perspective. The patterns in this acquisition are consistent with. Because of these factors. The reasons for AT&T’s persistence can only be conjectured.5 billion and negative synergies from the merger of as much as $3.0 billion.a storm to be weathered. Summary and conclusions AT&T persisted in acquiring NCR despite the market’s consistently negative reaction to major events during the negotiations.Having attained the right to enter the unregulated computer business. [See Kahneman. L.

consistent with its longstanding reputation as a benevolent monopoly (‘Ma Bell’). Healy. Journal of Accounting and Economics 9. if AT&T’s concerns about investor and analyst misinterpretation of the reported EPS under purchase accounting were justified. Ahson. Dechow. Patricia and Richard Sloan. June 9. However. Lys. 1991. be it $50 million or $500 million. Palepu. 85-107. 3-40. The effect of bond rating changes on common stock prices. Clearly. 1991..contradicting as it does the results of a significant body of research on this question. 57-89. AT&T’s management believed that the reduction in EPS under purchase accounting by roughly $0.45 per share in each of the next ten years would be detrimental to its share price as well as to its ability to raise capital. and E. The effect of accounting procedure changes on CEO’s cash salary and bonus compensation. Han Kim. Executive incentives and the horizon problem: An empirical investigation. Journal of Accounting and Economics 7. . this issuewarrants further analysis. then the additional amount paid to improve shareholder communications could be directly related to higher share prices. Foundations of finance (Basic Books. 7-34. 793-805.J. 1987. Journal of Financial Economics 21. NY). We cannot dismiss the possibility that the preference was due to executive compensation but we find no evidence that the choice was due to bond covenants. New York Times. 1991. This concern with EPS was further illustrated by AT&T’s plan to change to a 40% cash and 60% stock deal to mitigate the EPS dilution if the purchase method was required. D2. and Richard Thaler. 51-89. 1976. From an efficient markets perspective. Sok-Hyon Kang. Does the stock market overreact?. 1986. 1985. Michael. Arnand Desai. NCR accounting tactic could hurt any merger. 1985. p. Journal of Finance 40. We conclude that AT&T’s willingness to pay a premium for the pooling-ofinterests method of accounting was to avoid a sustained decrease in EPS because of the importance of investors’ perceptions. Journal of Financial Economics 17. Davis. Healy. The impact of bonus schemes on the selection of accounting principles. Eugene.M. Journal of Accounting and Economics 14. References Bradley. When AT&T plays hardball. Synergistic gains from corporate acquisitions and their division between the stockholders of target and acquiring firms. Paul. The question becomes whether the ‘window dressing’ afforded by the accounting choice was worth the price paid.this preoccupation with EPS. and Krishna G. Holthausen. 16-20. 1988. Cowan. Robert and Richard Leftwich. Pooling is associated with a ‘friendly’ acquisition and AT&T also desired to have the market perceive this business combination as friendly. New York. to the extent of paying a higher price to obtain a pure accounting benefit. Fama. L. L. March 22. New York Times Magazine.T. Vincent/Journal of Financial Economics 39 (1995) 353-378 371 telecommunications and computer technology without remaining in the computer manufacturing business. Werner F. Paul. De Bondt. is difficult to justify.

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