Overpriced Shares, Ill-Advised Acquisitions, and Goodwill Impairment

Abstract:     
We hypothesize that the root cause of many goodwill write-offs - managers' public admission of ill-advised corporate acquisitions - is the overpriced shares of buyers at acquisition. Overpriced shares provide managers with strong incentives to invest, and particularly to acquire businesses, even at excessive prices and doubtful strategic fit, in order to buy themselves out of the overpriced share predicament and postpone the inevitable price correction by portraying continued growth. We corroborate our hypothesis by documenting: (1) share overpricing is strongly and positively associated with the intensity of corporate acquisitions, (2) share overpricing is negatively related to the post-acquisition share performance of buyers, beyond the price correction, indicating a negative relation between overpricing and the quality of acquisitions, (3) share overpricing is positively related to the size of goodwill write-offs. We further show that share overpricing predicts both goodwill write-offs and their magnitude, and that acquisition by overpriced companies is a losing proposition for shareholders. Finally, we document some of the serious private and social consequences of the ill-advised acquisitions made by overpriced firms. These findings contribute to the accounting literature on business combinations and goodwill, as well as to the finance/economics research on investor sentiments and corporate investment.

JEL Classifications: G14, G24, G31, G34, M41, M44

Working Paper Series