Tradeoffs in income statement and balance sheet preferences: Evidence from acquirers’ goodwill valuations

Abstract

Academic and anecdotal evidence suggests that acquirers prefer to maximize the value of goodwill recorded in business combinations because doing so increases post-acquisition earnings when goodwill is not amortized. We conduct multiple studies with highly experienced professionals to test the idea that, when goodwill is amortized, acquirers prefer to minimize the value of goodwill on the balance sheet. We find that when goodwill is tested periodically for impairment and other intangibles are amortized, acquirers bias their acquisition-date valuations based on heterogeneous earnings-based preferences. In contrast, when all intangibles, including goodwill, are subject to amortization, acquirers shift their focus to the balance sheet and bias downward their acquisition-date valuation of goodwill. We also document that high uncertainty in acquirers’ private information about intangible asset valuations is a necessary condition for acquirers to act on their financial reporting preferences. Our study provides new insights about managerial discretion over accounting choices in the context of business combinations.

Keywords: intangible assets; goodwill; business combinations; mergers and acquisitions

JEL Classification: D81, M41