Overpaid Acquisitions and Goodwill Impairment Losses - Evidence from the US Market

The purpose of this study is to shed light on the reliability of accounting goodwill numbers by examining whether the root cause of many goodwill impairment losses is the overpayment for the target at the time of the original acquisition, rather than the deterioration of goodwill values caused by events occurred after acquisition. A second related objective is to assess whether the annual impairment test of the acquired goodwill introduced by SFAS 142 improved the ability of accounting standards to timely capture situations in which the amount of goodwill is overstated and should thus be written down.\r\nI tested these hypotheses over a sample of 929 acquisitions completed by US listed companies over the nine-year period from 1999 to 2007. To assess whether the occurrence of a goodwill impairment loss can be predicted based on overpayment indicators, I developed a prediction model of goodwill impairment losses using some indicators measured at the acquisition date that signal potential overpayment by the acquiring firm. First, I found that certain measures, such as the percentage of stock in the consideration and the amount of purchase price assigned to goodwill, in fact represent powerful indicators of the occurrence of a subsequent goodwill impairment. This result is troubling as it suggests that SFAS 141 provisions are at least partially unable to avoid that components other than “core goodwill” being included in the amount recognized as goodwill, casting some doubt on the credibility of prominent goodwill amounts included in the financial statements of many corporations. I also found that the recognition of goodwill impairments lags behind the acquisition time by an average of two to three years. Compared with findings of earlier studies this result indicates that SFAS 142 requirements for annual impairment tests in fact improved the timeliness of recognizing goodwill write-offs, eventually helping to mitigate the failure of SFAS 141.