Speculative Components in M&A Purchase Prices, Acquirers’ Long-Term Performance, and Goodwill Estimation

This study introduces an alternative method for mergers and acquisitions (M&A) accounting and demonstrates its diagnostic properties for predicting acquirers’ performance. While current accounting standards view an M&A as buying assets to add to the acquirer’s balance sheet, the proposed alternative approach views the purchase as buying the business of a target and the value in that business. Accordingly, the purchase price includes the value in the target’s balance sheet plus the added value of the business indicated by the income statement, with the remainder attributed to an alternative goodwill measure. This measure is immediately available to investors on the announcement of the acquisition rather than in subsequent financial reports. The paper shows that this timely alternative goodwill measure is (1) negatively related to the acquirer's long-term returns, (2) positively associated with the future impairments of goodwill reported under current generally accepted accounting principles (GAAP), and (3) incrementally informative over event-date market reactions and acquisition premiums for predicting long-term returns and goodwill impairments.