The Underlying Economic Components of Acquired Goodwill

Abstract

In this study, we investigate what makes up acquired goodwill and find that it consists of at least three distinct components: expected synergies from combining the assets of the target and acquirer, the going concern value of the target firm, and overpayment. We identify these components empirically through a factor analysis on target, acquirer, and acquisition characteristics. We then document that acquired goodwill is positively associated with the synergy value, going concern value, and residual components. Further, we predict and find that going concern value and expected synergies are associated with a lower risk of future goodwill impairment, but that synergies reduce the risk of goodwill impairment more than the going concern value component. We also find that overpayment is associated with a greater risk of future goodwill impairment. The evidence we provide on the nature of acquired goodwill is important to understand how to account for goodwill subsequent to the acquisition, as each of these components have a different effect on the future cash inflows to the entity. Our findings suggest that a one-size-fits-all subsequent accounting alternative for goodwill may be difficult to apply due to heterogeneity in the economic components of goodwill.

Keywords: Goodwill, Business Combinations, Mergers, Acquisitions, Synergies

JEL Classification: G34, M41