Case Study of a Successful M&A—The Role of Accounting and Finance in Lenovo’s Acquisition of IBM PC

It is a significant challenge bringing together two companies that have different cultural values concerning accounting and finance.  Lenovo and IBM adhered to different accounting standards and come from cultures that have divergent perspectives on secrecy, uniformity, optimism, and corruption.  These often-overlooked differences caused challenges for the merged company.

Accounting Methodology

There has been little to no release of information regarding the details of cultural difficulties in this particular area of the Lenovo-IBM acquisition, which is likely for financial confidentiality reasons. However, there undoubtedly were cultural conflicts within the accounting functions during the efforts to integrate Lenovo’s Financial Department, especially since Mary Ma, a Chinese employee, maintained the CFO position after the acquisition and had to figure out how to combine financial processes and departments. With the company now operating globally, financial requirements are even more complex. In this section, differences in accounting approaches between U.S. and Chinese nationals are presented in an effort to provide insight on common differences between these two cultures with regards to accounting functions.

Accounting Standards. As of 2007, the Chinese Accounting Standards (CAS) are required for financial statement preparation for Chinese companies.1 Although there are some differences—for instance, regarding leases, fair value methods, and impairment losses—the Chinese standards are considered to be quite close to International Financial Reporting Standards (IFRS), with the intent to converge them even further. Due to the nature of the principles-based IFRS, the convergence process has been a parallel of the difficult shift from China’s fixed, government-based economy to one with capitalist elements.2 U.S. Generally Accepted Accounting Principles are still quite different than both CAS and IFRS, and the U.S. is not in current pursuit of full convergence, which could mean difficulty in interpreting financial statements from the different systems.

Valuation. Chinese firms are often known for offering large premiums in M&A transactions. Reasons may vary: providing targets an extra incentive to overcome difficult regulation processes, investing in what is believed to be a long-term profitable venture, assuring entrance into a promising market, and in some cases, just overpaying through lack of experience.3 Additionally, a tendency towards long-term investments may have an influence on which financial statements are considered more important to each culture:

In the US there is greater emphasis attached to the income statement as the short-term financial performance is seen as crucial; such as cash flow, revenue and profitability, with the goal of quick results. However, the Chinese people have traditionally taken a long-term perspective of life throughout history, and they have emphasized tradition in order to secure a peaceful and reliable society. Therefore, China is significantly more long-term oriented, where the focus lies more on the balance sheet – emphasizing sustainability and a healthy financial position.4

This could result in a conflicting focus on financial performance, which could contribute to differing valuation preferences.

However, unlike what might be expected from a Chinese firm, Lenovo’s bid for IBM’s PC Division was considered by many to be a low price, even by U.S. standards. As one U.S. analyst said, “The price tag was a little bit lower than I would have expected.”5 Another U.S. academic said, “Maybe the price wasn’t as good as it could have been [for IBM].”6 Perhaps because IBM had been churning out constant losses from its PC department or because IBM highly valued the attainment of Chinese relationships, Lenovo was able to get a bargain on its purchase.

Professional Behavior

Professionalism vs. Statutory Control. China has a long history of very strict laws, governmental regulation, and expectations of conformity. Professionalism is very minimal since “the application of rigid and uniform accounting regulations has also not encouraged accountants to equip themselves with comprehensive analytical skills.”7 Because of this, China leans towards the “Statutory Control” end of the spectrum. The Chinese accounting profession does have intentions to move towards a more Anglo-Saxon style of accounting, which would include the use of more professional judgment necessary for the principles-based IFRS system, but the deep-rooted tendencies towards reliance on regulation may limit the pace of this intended shift.

Uniformity vs. Flexibility. China tends to have a uniform approach to accounting due to its strong government, weaker accounting profession, and long history of control. This shows the impact of the country’s Confucian heritage with its hierarchical emphasis and collectivistic mindset requiring a unified approach.8 In contrast, U.S. accountants tend to use flexibility in practice. This is not to say that U.S. accountants can simply apply accounting standards with any amount of freedom and flexibility. Rather, in the U.S., “there is more concern with inter-temporal consistency together with some degree of inter-company comparability subject to a perceived need for flexibility.”9 The U.S. accounting profession balances consistency with necessary adaptation.

 Conservatism vs. Optimism. Interestingly, China has historically had a mixed approach to these principles. Conservatism and prudence used to be regarded as a “tool of capitalist exploitation” and a “bias against working classes.” However, since the 1990s, conservatism has been accepted as a basic accounting principle and with time China has actually become very conservative, which impacts practices today.10 For example, “The historical cost principle is pervasive in asset valuation. Regular revaluations of assets and investments are not allowed. At the same time, the Ministry of Finance has been cautious in introducing new accounting practices.”11 These tendencies are in contrast with the U.S. accounting approach, which many studies consider to be among the most optimistic in the world with regards to measurement and risk-taking.12 With China’s mixed history on this principle contrasted with the strong favoring of optimism in the U.S., there were likely difficult transitions to be made with these principles.

Secrecy vs. Transparency. Typically, more transparent nations are viewed as “safer” for investment because there is not asymmetry of knowledge between capital market investors and corporations. “The transparency of corporate disclosure made by Chinese publicly listed companies has always been an issue. Companies are criticized for lack of disclosure [and] transparency and corporate scandals in recent years further strengthen this point of view.”13 The standards-based accounting approach of the U.S. strongly emphasizes disclosure of financial information for investors, while the uniform accounting system that the Chinese use does not.14

Transparency was recognized as an issue in the Lenovo M&A. After the acquisition, clashes between cultures grew since, “The Western leaders…were not accustomed to the secretive, noncommunicative approach that was more typical of the Eastern workplace culture.” Ironically, some of the Chinese workers perceived the Westerners as less transparent due to their adaptability: “Eastern managers may see Western leaders as being more objective and more willing to renegotiate goals as the context changes. This comes across as being less transparent and committed.”15 These different mindsets may have been difficult to coincide in the accounting realm. However, in recent years Lenovo has produced thorough annual reports of over 200 pages full of information and disclosure that show greater transparency and insight into the company’s operations. It appears that the U.S. tendency towards transparency has won over the company with regards to reporting.

Fraud/Earnings Management. The Chinese corporate world has had its share of fraud: “Extensive false reporting and earnings management by companies have discredited accounting information and hampered the development of the capital market.”16 The improvement of the accounting system and the strengthening of the profession are both efforts to combat this issue.

Regarding fraud in general, according to research from Transparency International—a global anti-corruption movement—China consistently receives a relatively unfavorable score in the “Corruptions Perceptions Index,” ranking countries by least to most corrupt.  In 2005, the year of the Lenovo-IBM acquisition, China ranked 78th out of 158 countries surveyed. In the same studies, the U.S. showed was ranked at 17th.17 Of course, this doesn’t mean that Chinese companies are invariably proponents of fraud and corruption. In fact, there seem to have been no claims—at least publicized claims—of fraud or earnings management on the part of either company involved in the Lenovo M&A.

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