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

Abstract

This study proposes and estimates a fundamental-analysis-based approach to identifying speculative components in merger and acquisition (M&A) purchase prices. I estimate the speculative component of the price as the portion that cannot be explained by the book value of the target plus a multiple of the target’s current earnings. I find that purchase prices that include a larger speculative component are negatively associated with future long-term returns. I also document that the speculative component of M&A prices is positively associated with future goodwill impairments. The results imply that the proposed approach helps predict the performance consequences of speculative M&A and provides an alternative framework for interpreting and evaluating goodwill.

Keywords: Goodwill accounting, Mergers and acquisitions, Valuation, Residual earnings model

JEL Classification: G32, G34, M41