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Accounting Research Center, Booth School of Business, University of Chicago

Valuation of the Components of Purchased Goodwill
Author(s): Steven L. Henning, Barry L. Lewis and Wayne H. Shaw
Source: Journal of Accounting Research, Vol. 38, No. 2 (Autumn, 2000), pp. 375-386
Published by: Wiley on behalf of Accounting Research Center, Booth School of Business,
University of Chicago
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Comments from Randolph Beatty. and the University of Wisconsin-Madison Doctoral Alumni Conference are gratefully acknowledged.* AND WAYNE H. the University of Texas at Austin. Jody Magliolo. John Robinson. tUniversity of Colorado at Boulder. and workshop participants at the University of Colorado at Boulder. Texas Christian University. HENNING. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions . the University of Notre Dame. 375 Copyright ?.26. and Landsman's [1992] analysis of the value relevance of the components of pension expenses under Statementof Financial Accounting Standards No. L. calculated as the difference between *Southern Methodist University. Introduction This paper examines whether investors distinguish among identifiable components of goodwill for valuation purposes. Terry Warfield.Journal of Accounting Research Vol. As detailed in section 2. Todd Johnson. SHAW* of LEWIS.t 1. we decompose the difference between the acquisition price and the preacquisition book value of the target firm's assets into four components: (1) the write-up of the target firm's assets to fair market value (WRITEUP). Kimberley Petrone. we use contemporaneous stock price and returns regressions to examine investors' valuation of the components of goodwill and their amortizations. Valuation of the Components Purchased Goodwill STEVEN L. 2000 This content downloaded from 210.A. 16: Accountingfor Business Combina- tions [1970] requires firms to record only the total excess of the purchase price over the fair value of identifiable assets and to amortize this asset over a period not to exceed 40 years-market participants can readily calculate goodwill components from publicly available data. Although current accounting practice does not require firms to disclose components of goodwillAccounting Principles Board Opinion No. Institute of Professional Accounting. in the year of acquisition.2 on Sun.187. Thomas Linsmeier. 2 Autumn 2000 Printed in US. Robert Lipe. Similar to Barth. Toby Stock. the University of Waterloo. BARRY L. 87. 38 No. Beaver.

we find that investors attach different valuation weights to the components of goodwill.01 level) positive relation between market values and the synergy component of goodwill.and a significant negative relation between returns and the amortization of RESID. For a sample of 1. calculated as the combined cumulative abnormal returns to the target and the acquirer for the 11 days centered on the acquisition announcement. (3) the market's valuation of the synergistic value created by the acquisition (SYNERGY).while other goodwill components may not be assets. Johnson and Petrone [1998] propose a measure of core goodwill equal to the sum of the going-concern value of the target and the synergies created by the acquisition. However.187.e. entity (GC). the result that investors attach a significantly larger weight to SYNERGYthan to GCsuggests there is incremental This content downloaded from 210. SYNERGY. Although the FASBwas not explicit in its definition of "core" goodwill.GC. Our finding that investors place positive weights on GCand SYNERGYis consistent with investors perceiving core goodwill (under Johnson and Petrone's definition) as an asset. with the magnitude of the coefficient on GCequal to that on nongoodwill assets and on the write-up of the target's net assets to fair market value. and SYNERGYCurrent GAAPrecords as purchased goodwill on the acquirer's books only the aggregate of GC.and RESID.26. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions .376 JOURNAL OF ACCOUNTING RESEARCH.576 acquisitions between 1990 and 1994. and (4) any overvaluation of consideration and/or overpayment for the target (RESID). or standalone. the coefficient on SYNERGYexceeds one).if their total is positive. The results show a significant (at the .2 on Sun. WRITEUP. we find no evidence that the market places a continuing value on the residual component of goodwill. The results show no association between returns and amortizations of GC and SYNERGY. in fact.The latter result is consistent with the market viewing the residual overpayments as expenses. We also document a significant (at the ..calculated as the purchase price less the sum of the preacquisition book value of the target's assets. with the magnitude of this relation suggesting that investors view the acquirer as receiving additional synergy gains (i. consistent with the market writing off overpayments in the year of acquisition. We also examine the relation between stock returns and the amortization of goodwill components in the first year of the combined operation of the acquirer and target. Our study provides evidence that speaks to the Financial Accounting Standards Board's (FASB)view that a "core" goodwill component is conceptually an asset (under the four criteria in ConceptsStatementNo.03 level) positive association between market values and the amount of going-concern goodwill. (2) the value of the target as a going-concern. AUTUMN 2000 the fair market value of the target firm's assets and their preacquisition book value. 5: Recognitionand Measurementin Financial Statementsof BusinessEnterprises). the results show a significant negative association between RESID and share price. Finally. calculated as the difference between the target's preacquisition market value measured six days prior to the acquisition and the target's fair market value of assets.

Finally. if not disclosed. The final sample consists of 1. 2. and information included in the SecuritiesData CompanyUS. Sample and Data The initial sample includes 3. and section 4 concludes.576 purchase combinations. For each of the 1. acquirer firms' financial statements. ranging from 253 in 1990 to 384 in 1994. We eliminate 1.2 on Sun. A cross-sectional pooled fixed-effects regression that includes separate intercepts for each firm and separate intercepts and slope coefficients for each year. This content downloaded from 210. using all firm-years across the five-year period. Section 2 describes the sample and data. adjusted for acquisitions or dispositions of goodwill other than by systematic amortization. The preacquisition book value of the target's assets is obtained from disclosures in the final annual reports or l0Qs filed by the target. the sample-wide asset write-up is $42 million (16% of purchase price) and the amount of goodwill is $177 million (57% of purchase 1 We exclude firm-years with no acquisitions because we are interested in how goodwill is valued in the year of the acquisition. The average acquirer is about seven times the size of the target based on total assets. purchased goodwill. and with dividend and book value data available on Compustatand market price and returns data on CRS1We collect information from these firms' annual reports on current additions to. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions . provides virtually identical results for both the balance sheet and income statement models. section 3 reports the tests and results. Table 1 reports descriptive information about the sample acquisitions.VALUATION OF PURCHASED GOODWILL 377 information provided by disaggregating core goodwill into its synergy and going-concern components.' We delete another 165 firm-year observations because a portion of the purchase price is allocated to in-process R&D. The average acquisition price of $319 million is substantially higher than the mean book value of the target's assets ($100 million) and the mean fair value of the target's assets ($142 million). On average. is inferred as the change in the carrying value of goodwill. we collect data on the current increments to goodwill and the fair value of the assets purchased from prospectuses and 8K filings.576 sample observations.187. our finding that the market places a negative weight on RESIDis consistent with the FASB'sview that not all components of goodwill are assets and that some components-notably RESID-may overstate the economic value of purchased goodwill.26. and preexisting carrying values of. and about three to four times the target size in market value terms (market values measured six days prior to the acquisition announcement). Mergersand Acquisitionsdatabase.097 Compustatfirm-year observations with a goodwill asset in any fiscal year t = 1990-94.356 firmyear observations because no business combination accounted for the purchase method used during any of the five sample years. Goodwill amortization.

on a going-concern or stand-alone basis.239 $25.593 $138.832 $194.1% $0 0.637 $100.194 60.0% 0. during the acquisition period.584 4.187.259 $ 41.847 56. AND W. and (3) the ability of the enterprise to earn. using an 11-day window centered on the initial and all subsequent announcements. Write-Up is the excess of the fair value of net assets acquired minus their book value.2% $ 66. Purchase Price is the amount paid for the target.430 a Median 6.184 $87.9% $ 39. if any.378 S.099 Variable definitions: Ratio of Acquirer to Target Assets is the ratio of the acquirer's book value of total assets to the target's total assets.044 45. Residual Goodwill is the purchase price minus the preoffer market value of the target (market value measured six trading days prior to the first announcement) minus synergy goodwill.826 20.216 11. The amortization expense for the goodwill in the event-year acquisition is approximately 7% of the reported combined income. 3.0% 0. L. Going-Concern Goodwill is the excess of the preoffer target market price (market prices measured six trading days prior to the first offer) over the fair value of the net assets acquired. The acquisition-related components are: (4) the fair value of synergies from This content downloaded from 210.9% $ 85.3% $ 58.5% $ 88.391 14. The target-related components are: (1) the excess fair value of recognized assets over preacquisition target book values. measured in the last reporting period preceding the acquisition date.305 $51. Synergy Goodwill is the cumulative net increase in market value of both the target and acquiring firm. Book Value of Acquired Assets is the book value of the target firm's assets at the end of the reporting period preceding the acquisition announcement.7% $0 0. Empirical Work Johnson and Petrone [1998] divide the excess of purchase price minus the preacquisition target book value of assets into six components relating to the target and to the acquisition. Incremental Goodwill Amortization is the portion of year t amortization expense associated with the purchase combination occurring in year t. L. Goodwill is the excess of the purchase price over the fair value of the net assets acquired.068 3d Quartile 9. HENNING.927 3.173 58.9% $34.656 48. a higher return on a collection of net assets than would be expected if those net assets were acquired separately.635 39. ($ Millions) Ratio of Acquirer to Target Assets Ratio of Acquirer to Target Market Value Purchase Price Book Value of Acquired Assets Write-Up Percentage of Purchase Price FairValue of Assets Goodwill Percentage of Purchase Price Going-Concern Goodwill Percentage of Goodwill Synergy Goodwill Percentage of Goodwill Residual Goodwill Percentage of Goodwill Ratio of Incremental Goodwill Amortization to Net Income Mean 7.273 3. SHAW TABLE 1 Descriptive Information on the Sample Acquisitions.742 2. H.962 $ 31.576 $221.6% $204. Ratio of Acquirer to Target Market Value is the ratio of the acquirer's market value of common stock to the target's market value of common stock.572 $ 66. LEWIS.7% $16.665 $318.604 48.2% $ 37. aThe sample consists of 1.862 43.731 34. Fair Value of Assets is the fair market value of the net assets acquired. B.575 16.576 purchase acquisitions occurring during 1990-94 which resulted in purchased goodwill on the acquirer's books.011 20.905 $397.2% $127. where market values are measured six days prior to the first acquisition announcement.382 67. price).834 $176.584 $ 95.5% $ 53.827 32.1% $141. (2) the fair value of previously unrecognized assets. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions .084 16.985 30.494 $10.071 1990-94 1st Quartile 4.2 on Sun.8% $ 37.716 $ 96.3% 0.7% $35.6% 0.26.

They argue that the sum of the changes in the market value of equity of the target firm and of the acquiring firm to the announcement of the acquisition provides a firm-specific measure of synergy gains. Thus. Our tests examine whether market participants place different valuation weights on the components of goodwill by disaggregating the excess of purchase price minus the book value of assets acquired into four components: WRITEUP. the FASBreaffirmed that goodwill is an asset but expressed concern that the value of this asset might be overstated by the inclusion of components 5 and 6. The results are robust to using CRSP beta-portfolio excess returns.RESID proxies for the sum of components 5 and 6. we define RESID as the excess of purchased goodwill over GC and SYNERGY. about whether components 5 and 6 should be included. WRITEUPis a control variable in our tests.187. however. [1996] and Vincent [1997] which uses balance sheet and income statement models to assess the value relevance of purchased goodwill and its amortization. results are not sensitive to equal. 5 In instances where the initial bid is rejected. and Kim's [1988] model to estimate the magnitude of the synergy gains of the transaction. We calculate abnormal returns using market model prediction errors.VALUATION OF PURCHASED GOODWILL 379 combining the acquirer's and target's businesses and net assets. 16. we aggregate abnormal returns over the initial announcement and subsequent bids. in a June 1998 summary of current Board actions. (5) payments resulting from over. Our empirical tests follow recent work by Jennings et al. For a sample of firms involved in corporate mergers. Market model parameters are estimated separately for acquirer and target using returns on days (-300.GC.(under-) payment by the acquirer in the course of bidding. 4This definition assumes that acquisitions have no effect on the wealth of bondholders and other claimants. There is some question. This content downloaded from 210. goodwill consists of components 3-6.and RESID.equal to the excess of the fair values of acquired net assets over their net book values. The balance sheet model regresses market value on goodwill and nongoodwill assets and liabilities.5 Finally. and (6) over. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions . because we expect that investors value WRITEUPsimilarly to GC.3 Component 3. Desai. Kim and McConnell [1977] and Asquith and Kim [1982] provide evidence consistent with this assumption. is measured as the difference between the fair value of assets recognized and the preacquisition market value of the target.(under-) valuation of the consideration used. even though it is not a component of goodwill. In particular.2 Under APB OpinionNo. SYNERGY. We use Bradley.4 We use the combined cumulative abnormal returns to the target and acquirer in the 11-day window centered on the acquisition announcement (SYNERGY)to proxy for component 4.26. while the income statement approach 2Rau and Vermaelen [1998] and Wiedenbaum and Vogt [1987] find support for the concern that the competitiveness of the acquisition market may result in systematic overpayment for targets.Components 1 and 2 are combined in the variable WRITEUP. 3We include WRITEUPin our analysis.2 on Sun. -61) relative to the day 0 announcement of the first bid for the target.versus value-weighted market returns. going-concern goodwill (GC).

The finding that the coefficient relating goodwill assets to market value exceeds 1. H.Investors may also value GC.and RESID differently if those components have different service lives. Given that WRITEUPand GC are included in the preacquisi6A related explanation for the high coefficient on goodwill is that goodwill does not decline in value and. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions .and RESID are calculated as previously described and are adjusted for the amortization expense accruing between the acquisition date and the end of year t. L. For example. LEWIS. [1996]. One explanation for the high coefficient on reported goodwill is that investors differentially value the components of goodwill. and t is the fiscal year the acquisition occurred.2 on Sun. and LIAB is expected to have a negative coefficient.0) weight to RESID. we expect investors to attach a significantly lower (than 1.26. with the estimated valuation weight exceeding 1. if excessive payments to the target overstate the value of the "core" goodwill asset.0 leads the authors to conclude that reported goodwill understates the value of this asset to the acquirer. GC. L. both studies find that goodwill is significantly positively related to share price. goodwill amortization increases any understatement due to benefit sharing. GW*is the purchased goodwill from acquisitions prior to year t. This content downloaded from 210. AND W. HENNING. Consistent with Jennings et al. We test whether investors value the components of goodwill differently using the following regression equation: MVj t = + lBVJt + 02GW)-W+ 03WRITEUPj t + ?4aGCjt + 04bSYNERGY/. BVb and GW* are predicted to have positive coefficients. the coefficient relating market value to purchased goodwill could exceed one if the acquiring firm extracts more synergy benefits from the transaction than what it paid for these benefits. All variables are scaled by the number of shares outstanding at the end of year t. and that goodwill amortization is not significantly related to returns.7 BV*(LIAB) is the book value of the combined entity's nongoodwill assets (total liabilities) at the end of year t..6 This argument predicts that the coefficient relating the market value of equity to SYNERGYexceeds the coefficient relating market value of equity to either GC or RESID. In particular.e. B. therefore. We expect such benefit sharing if there is private information about the synergistic gains to the acquirer which are revealed (fully or partially) after the initial disclosure. SYNERGY. 12or 15-month) stock returns and goodwill amortization and pregoodwill amortization earnings. investors will attach a nonpositive weight to the residual component.380 S.t + 04cRESIDt + 05LIABjt + ?j t (1) where MVis the share price at the end of the first quarter of year t + 1. 7 We measure share price at the end of the first quarter of t + 1 to ensure that all year t accounting variables (such as earnings and book values) are known by investors. Results using market prices at the end of firm j's fiscal year are similar and are not reported.0.187. SHAW examines the contemporaneous relation between long-window (i. SYNERGY.In the extreme case where RESID is not an asset at all. In general.

03 level).04b.0 (at the . not reported. we find the coefficient on goodwill from prior-year acquisitions (GW") to be significantly greater than zero. 04c.8 In calculating SYNERGY.02 level. respectively.43% and 75% numbers reported by Bradley.2 on Sun. these proportions are similar to the 7. Desai.and RESADdoes not exceed the amount of goodwill recorded in the financial statements. SYNERGY.26. panel A.0 and -1. 9F-tests of the equality of the coefficients (not reported) are significant at the .and RESIDrepresent 21%. we expect that the target firm receives full payment for these components. We report results using both the Full sample of 1. Consistent with Jennings et al.Because the results are similar.01 level) and approximately equal to 1. of recognized goodwill. This content downloaded from 210. consisting of the 697 (1. Before discussing the results of estimating expression (1). we expect the market to view this component as not an asset (i. 8In calculating SYNERGY.03 levels.we find that the combined value of the target and acquiring firms increases. and Kim [1988] for a sample of tender offers during 1963-84.0. suggesting that the acquirer shares in the synergy gains. suggesting that investors not only do not value RESIDas an asset but view RESIDas detracting from firm value. Finally.we note that the average combined market reaction to the acquirer and target is positive and in excess of the total goodwill recorded in 879 of the 1.01 and . 0).9 In contrast. the coefficient on RESIDis negative (significant at the . Table 1 shows that the average values of GC.. Consistent with prior studies. In these 879 cases. we set RESADequal to zero so that the sum of GC. respectively) and are indistinguishable in magnitude from the coefficient on the book value of nongoodwill assets. This reasoning suggests that 03 and 04a. is significantly greater than both 04a (the F-statistic. SYNERGY.576 transactions. are positive and approximately equal in magnitude to 1. The results of estimating equation (1) are shown in table 2.31%. We test whether and how the market separately values the synergy component by examining whether 04b > 04a and 04b > 1. we discuss only those for the Full sample.576 firm-year observations and the Unrestricted sample. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions . the coefficients on BV* and on LIABare significant (at the . Finally.01 level) and 1. is significant at the . on average. the coefficient on SYNERGY. 48%. In these cases. and 31%. we first provide information about the magnitude of the goodwill components of the sample transactions. Examination of 03 04a' 04b' and 04c reveals that investors value the asset write-up and goodwill components differently. with 84% of the sample observations having positive combined abnormal returns.VALUATION OF PURCHASED GOODWILL 381 tion target firm's market value.01 level). the coefficients on WRITEUPand GC are significantly positive (at the . [1996]. respectively. we constrain SYNERGYto the excess of the purchase price over the preoffer market price six trading days prior to the first offer.e.576 less 879) firm-year observations where we did not have to constrain SYNERGYor RESID.187. Consistent with expectations. if RESID captures the transfer of wealth from shareholders of the acquirer to shareholders of the target. by 6.

qct This content downloaded from 210. LEWIS. SHAW ~~~~~~~~ Co -~~~~4 Co.Z r &boH~ u 4 . 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions .26. . or ( . L. CO ~ ~ ~ ~ ~ c m-0 ' 0~~~~~~ 0 -0 0 C' ~Z ICO0b 0 o ~~ OO~~~~-'~~~--~~~~ + ~~~~-'00O ~~~~~~~oo~Q ~~~ o ~ :Z o0 0 < ~~~~~~~~~ ~ ~ ~ ~~~~~~~~~~~~~~~~~~~~~ 0U C) ---q Cl ~~~C~~~~~QC~~~~~ "~clC Ct tcl n _ Q0 ~~Ci? Q ~~~ . B. HENNING.- o~~~~ ~ ~ ~ ~ ~ ~ ~ 403 ~ ~ ~ ~ ~~ 00 r. AND W.2 on Sun. H. L.187.382 S.

This allocation applies the same firm-specific service life to each goodwill component.GWASYNERGy. the balance sheet results are consistent with the view that investors differentially value the components of reported goodwill. and the subscripts GC. another 20% assigned a single period less than 40 years.26.15 The independent variables in (2) are scaled by beginning-of-the-year market value. [1996] to consider investors' valuation of the components of goodwill amortization expense:10 + 72GWA> + Y3aGWAGCjt+ + Y3cGWARESIDjl + jt Y3bGWASYNERGYj. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions . we adjust goodwill amortization to an after-tax basis.187. We draw qualitatively similar conclusions using the statutory rate for all firm-year observations. 13We do not include a separate variable for the amortization of WRITEUPbecause the depreciable lives on the purchased identifiable assets are generally not disclosed. Molloy. we add back goodwill amortization since the goodwill from these acquisitions was not deductible for tax purposes.VALUATION OF PURCHASED GOODWILL 383 In summary. For post-1992 acquisitions. Incremental goodwill amortization is calculated using the service life disclosed (1. About half the sample observations assigned a 40-year life to the incremental goodwill.t Rjt = Yo + yA* (2) where R tis the dividend-adjusted return for the 12-month period ending on the last day of the first quarter of year t + 1. and the remaining 30% assigned multiple service lives.14 From table 1.12 GWA*is the amortization of goodwill existing prior to the event-year acquisition. and GWApESpwe apportion the incremental goodwill amortization for each firm using the fraction that each component represents of the total incremental goodwill asset. embedded in A*. we estimate the firm's tax rate as its current federal income tax expense divided by pretax earnings (minus equity income from unconsolidated subsidiaries plus income from minority interests).13 To calculate GWAGc. Following Lev and Thiagarajan [1993] and Omer.148 observations) or is inferred as the excess of the current amortization over previous amounts. this rule allocates an average 21% of incremental goodwill amortization to GWAGC. We provide further evidence on the valuation of the components of goodwill by expanding the income statement model used by Jennings et al. The amortization of 4WRTEUP is. and firms with a positive numerator and a negative denominator are assigned the statutory tax rate (34%).11 At is earnings before goodwill amortization and extraordinary items for year t.2 on Sun. 14Incremental goodwill amortization is the portion of year t goodwill amortization from acquisitions made in year t. synergy and residual goodwill. respectively. 1 Results are similar using stock returns cumulated over the firm's fiscal year. SYNERGY. we examined the sensitivity of the results to using the shortest life for calculating the amortization of RESID. This content downloaded from 210. Firms having both a negative numerator and denominator are assigned a zero tax rate. 12 To calculate earnings before goodwill amortization prior to 1993. and RESID reflect the amortization of eventyear additions to going-concern.48% to GWASYNERGy' and 31% to GWApESID. and Ziebart [1991]. 15 For firms reporting multiple service lives. therefore. and the other lives to calculate the amortization of GC and SYNERGYResults (not shown) are similar to those reported.

These tests (not reported) show insignificant coefficients on the RESID and GWARESID variables in both years. again. our results on the capitalization and amortization of RESIADgoodwill are subject to an errorsin-variables problem because of the allocation of the preoffer market price to the net assets that the target sells and those it retains. The coefficients on the amortization variables remain insignificant.17 We interpret the in year t. the coefficients on RESID in the balance sheet in the income statement model are significantly model and on GWARESID negative for both 100% and less-than-100% purchases. While the amount of SYNERGY goodwill 16As a sensitivity check.187.01 level). L.26. panel B. we expect the coefficients to equal -1. We reestimate equations (1) and (2) separately for the 1. [1996].012 (564) transactions in which 100% (less than 100%) of the target is acquired. 17 GC and SYNERGY continue to show significant positive relations with price in years returns in years in explaining t + 1 and t + 2.2 on Sun. and RESAD amortizations capture declines in the values of the goodwill components. we present results for both the Full and Unrestricted samples but discuss results for only the former given the similarity in conclusions. SYNERGY. LEWIS. This content downloaded from 210. GWAGCand GWASYNERGy are insignificant t + 1 and t + 2. we replaced observations with partial-year amortizations with a full year's amortization to assess the effect on the results of the timing of acquisitions during the fiscal year. We also find that GWAGCand GWASYNERGY are unrelated to returns in the acquisition year. We also examine the sensitivity of the results in table 2 to the inclusion of less than 100% purchases and to industry differences in component goodwill valuation. If a component of goodwill is a nonwasting asset.16 In contrast. L. suggesting that investors view the amortization of these payments as reducing firm value in the acquisition year. HENNING. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions . AND W.384 S. we reestimate equations (1) and (2) for each of the 21 two-digit SIC codes containing at least 30 observations. In particular. and the absence negative coefficients on RESID and GWARESID of significant relations for these variables in postacquisition years. as evidence that the market writes off overpayments in the year of acquisition. SHAW Equation (2) permits direct tests of whether GC. These results (not reported) are similar to those documented for the combined sample. or decays in ways that straight-line amortization does not capture. The results of estimating equation (2) are summarized in table 2. B. Consistent with Jennings et al. Concerning the first issue. the coefficient on GWARESIDis significantly negative (at the . by examining the We probe the results involving RESADand GWARESID significance of these variables in explaining prices and returns in years t + 1 and t + 2. If they do. the goodwill amortization coefficient will not be significant. To ensure that our results are not driven by a particular industry. H. the coefficient on preacquisition year purchased goodwill amortization (GWA*) is indistinguishable from zero.

Consistent with concerns that some components of goodwill are assets while others are not. we find that both components are significantly positively related to market value. 4. and any overvaluation of consideration and/ or overpayment for the target. both the going-concern component and the synergy component are significantly positively valued by the market. We partition GAAP reported goodwill into the target firm's value as a going concern.g. In particular.. a significant negative relation between returns and the amortization of the residual component in the year of the acquisition. Consistent with Johnson and Petrone's [1998] measure of core goodwill as the combined value of going-concern goodwill and synergy goodwill. Conclusion We examine whether the market distinguishes among identifiable components of goodwill for valuation purposes. The latter result suggests that. acquirers pay less than their reservation price for the assets and share in the benefits of the acquisition.2 on Sun. these results support the components approach to accounting for goodwill that was considered (and rejected) by the FASB. our results show that investors attach positive and negative weights to components of goodwill.187. Overall. Beaver. suggesting information is lost from aggregating the two pieces. on average. An income statement model examining the relation between stock returns in the year of the acquisition and the component goodwill amortization charges shows no significant relation between returns and the amortization of the going-concern or synergy components. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions . Finally. Results for the income statement model are similar to those reported for the Full sample. the result that investors do not view the residual component of goodwill as an asset is consistent with the FASB's view that this component likely overstates This content downloaded from 210. Further tests show that investors place a significantly larger weight on the synergy component than on the going-concern component. We also find that investors place a significantly negative value on the residual goodwill component. however. the coefficient relating SYNERGY to market value of equity is stable across the 21 industry subsamples. with the going-concern component valued similarly to nongoodwill assets and the synergy component receiving a higher weight. the synergy gains of the business combination. and Landsman's [1992] analysis of components of pension expenses. which captures amounts in excess of the net increase in market value to the parties to the transaction.26.VALUATION OF PURCHASED GOODWILL 385 varies across the industries (e. We document. synergy goodwill is a higher fraction of purchase price for high-technology firms than for heavy manufacturing firms). The components approach we use is similar to Barth. These results and synergy components are nonsuggest either that the going-concern wasting assets or that the assumed amortization rule does a poor job of capturing the declines in the values of these assets.

Finance. LANDSMAN. OMER. SHAW current GAAP recorded goodwill. New York: AICPA. KIM. AND E. VINCENT."Fundamental Information Analysis. Our finding of a negative valuation weight on this component suggests that investors effectively write off this portion of the goodwill asset in the year of the acquisition. "Is Goodwill an Asset?" Accounting Horizons (September 1998): 293-303. "The Market Valuation Implications of Net Periodic Pension Cost Components. AND W. JENNINGS. 1970. M. B. H. Value and the Post-Acquisition Acquiring Firms. THOMPSON. DESAI. MCCONNELL. REFERENCES ACCOUNTING PRINCIPLES BOARD. A. and Accounting (June 1996): 513-33. P." Journal of Financial Statement Analysis (Summer 1997): 5-19. PETRONE. M. "Takeover and Stockholders: Winners and Losers. H. LEWIS.." ASQUITH. R.2 on Sun. R. B. "Equity Valuation Implications of Purchase versus Pooling Accounting. K. K. Opinion No. AND J. H. AND T. KIM. R. BARTH. M. 29 Nov 2015 02:53:27 UTC All use subject to JSTOR Terms and Conditions . for Heteroskedasticity. "The Relation between Accounting Goodwill Numbers and Equity Values. VERMAELEN. DUVALL. AND K. 16: Business Combinations. H. "The Impact of Merger Bids on the Participating Firms' Security Holders. WIEDENBAUM." Journal of Accounting and Economics (March 1992): 27-62. E. JOHNSON.. J. LEV."JournaloftheAmerican TaxationAssociation (Spring 1991): 57-72. Covariance Matrix Estimator and a Direct Test WHITE. "Synergistic Gains from Corporate Acquisitions and Their Division between the Stockholders of Target and Acquiring Firms." Journal of Financial Economics (August 1998): 223-53. BEAVER.. This content downloaded from 210." Journal of Business. HENNING. Performance of RAU. L. P. AND L... VOGT.. L. T. MOLLOY. AND D." Journal of Finance (May 1977): 349-65.26.. AND W. H." Journal of Finance (December 1982): 1209-28." California Management Review (Summer 1987): 157-68.386 S. L. W. R."Measurement of Effective Corporate Tax Rates UsingFinancial Information. BRADLEY. R." Journal of Accounting Research (Autumn 1993): 190-215. "Glamour. E. AND S. R. L.187. "Corporate Merger Activity and the 'Co-Insurance' of Corporate Debt. "A Heteroskedasticity-Consistent Econometrica (May 1980): 817-38. ZIEBART. THIAGARAJAN." Journal of Financial Economics (May 1988): 3-40. AND S. KIM... ROBINSON.. AND E.