Hearing on Pooling Accounting

Prepared Testimony of Mr. James Barksdale
The Barksdale Group

10:00 a.m., Thursday, March 2, 2000 - Dirksen 628

Chairman Gramm and members of the Committee, thank you for the opportunity to testify today. My name is Jim Barksdale and I am Managing Partner of the Barksdale Group, a leading investment and advisory group committed exclusively to growing companies in Internet services. Prior to forming the Barksdale Group, I held a number of positions in various companies and industries. I served as Chief Operating Officer of Federal Express, Chief Executive Officer of AT&T Wireless and most recently, President and Chief Executive Officer of Netscape. I currently serve on the Board of Directors of a wide range of technology companies, including America Online, Sun Microsystems, Respond.com and Liberate Technologies.

I strongly disagree with the FASBs plan to eliminate the pooling-of-interests method of accounting. I believe that the elimination of pooling will discourage mergers and acquisitions, will have a negative impact on the U.S. economy, and will create financial statements that are, at best, irrelevant and, at worst, misleading.

The elimination of the pooling method will discourage mergers of knowledge-based companies and will have a chilling effect on the flow of venture capital to promising new sectors. Poolings have proven to be an effective and efficient way for companies to integrate new intellectual property and innovations into their operations. At the same time, the prospect of such combinations has provided incentives to the start-up companies that have driven much of the technology sectors innovation. FASBs proposed elimination of pooling will discourage such combinations, will make it harder to attract institutional capital and -- ultimately -- will dampen desirable business activity. Still worse, these negative impacts will occur without any improvement in financial statement reporting.

From my own experience, I can tell you that the AOL/Netscape merger would not have occurred if pooling had not been an option. The bulk of Netscapes value was intangible, and the amount of resulting goodwill that would have had to be amortized under the purchase method would have scuttled the deal. A report prepared recently by Merrill Lynch attempted to show the impact on AOLs earnings if it had been required to use the purchase method in the Netscape transaction. If AOL and Netscape had used the purchase method, its 1998 loss would have been roughly ten times greater.

Now, we are all aware that AOL has agreed to acquire Time Warner in a purchase transaction. The press has reported that AOL may decide to sell significant Time Warner assets and to buy back stock. Either of these events alone would prevent the use of the pooling method. Because the AOL/Time Warner deal did not qualify as a pooling, it is not relevant to our discussion today.

What is relevant is that analysts have said from the day the AOL/Time Warner deal was announced that because the deal is so huge, they intend to ignore the GAAP financial statement reported earnings and, instead, focus on operating cash flow.

To the extent analysts expand this trend of ignoring amortization charges, it will make the GAAP financial statements increasingly irrelevant for those companies that are large enough to be followed by analysts on a regular basis.

This is compelling evidence that financial reporting will not be improved by FASBs proposed change. In fact, financial statements will become less transparent. Analysts will ignore the drag on earnings caused by the use of purchase accounting in those transactions that are large enough to be closely followed by the market. For mid-sized or small companies, however, analysts and investors will not have sufficient information to enable them to look through intangible asset amortization. The same phenomenon is also likely to occur in the case of smaller transactions involving large companies.

As a result, there will be different earnings benchmarks in the marketplace depending on the size of a transaction or the size of a company. Investors will not have the same type of cash earnings information or analysis for all companies. Similarly, requiring the use of purchase accounting will impair, not improve, comparability between the financial statements of companies that grow internally versus those that grow through business combinations.

FASB has identified an important issue -- the need to improve accounting for intangibles. While there is a virtually uniform approach to valuing certain intangible assets such as cable systems and copyrights, consistent and well-tested valuation methods simply do not yet exist for many of the intangible assets that comprise todays companies. For example, FASB has proposed that favorable government relations is a separately identifiable intangible asset. We have no guidance, however, as to how that asset should be identified, valued or lifed. As it stands now, if you asked five different valuation experts to value that intangible asset and determine its useful life and you would get five different answers. The lack of uniformity on these important issues will result in inconsistencies in the allocation of the purchase price between identifiable intangible assets and the residual goodwill between different companies. For this additional reason, consistency in financial reporting will not be improved.

One final point deserves mention. Some have argued that pooling should be eliminated because it allows one company to overpay for another company or encourages companies to enter into unsound business combinations. Even where both sides to a merger want the deal to be completed, the parties do not have entirely common interests. As a result, the value of the consideration exchanged is, by definition, determined at arm's length. In addition, corporate managers and directors have fiduciary responsibilities to their shareholders. To the extent those fiduciary duties are breached, the legal system, not the accounting system, should address those problems.

I believe that we have an opportunity to develop a financial reporting model that provides accurate information to investors in the New Economy and that does not hinder the tremendous economic growth fueled by the technology industries. We should do so in a careful and thoughtful manner. There is no compelling rationale for the speedy elimination of pooling without thoughtful consideration of these larger issues. I look forward to a continued dialogue on these important issues and welcome your questions.

Thank you.

Home | Menu | Links | Info | Chairman's Page