Balancing risk and reward: The influence of FAS 123R on cross-border M&As

Abstract

Cross-border mergers and acquisitions (M&As) constitute the primary channel of foreign direct investment but involve substantial risk due to informational frictions, institutional differences, and the liability of foreignness. This study examines how accounting regulation affects such high-risk investment decisions by exploiting the adoption of Financial Accounting Standard (FAS) 123R, which required firms to expense stock options at fair value and thereby altered CEO risk-taking incentives. Using a difference-in-differences design that leverages cross-sectional variation in firms' exposure to the accounting reform, we document a significant decline in cross-border M&A activity following FAS 123R. The reduction is concentrated in settings where investment risk is higher, including acquisitions in culturally distant or civil-law countries, as well as among weakly governed firms and non-diversifying deals. Importantly, despite fewer acquisitions, firms more affected by FAS 123R undertake higher-quality cross-border M&As, as reflected in higher announcement returns. Overall, the findings provide causal evidence that accounting-driven changes in executive compensation reshape managerial risk-taking and improve the quality of firms’ international investment decisions.