Accounting for Goodwill

Abstract

A significant portion of a merger’s purchase price is allocated to goodwill. Currently, goodwill is not amortized but tested annually for impairment. When managers care about earnings, goodwill’s accounting treatment can have large effects on future earnings and may influence how much a manager will bid for a target company. We quantify the effects of goodwill accounting by estimating a structural model of corporate takeovers. Our estimates suggest that accrual accounting increases buyout premia by an average of nearly 10 percentage points. If firms needed to amortize goodwill over 10 years, we estimate premia would reduce by 6 percentage points and M&A volume would shrink by 4.29% or $68.6 billion per year. Furthermore, the fraction of private equity acquirers increases by 7.74 percentage points, shifting control over productive assets to the private and financial sector. Our results suggest the accounting treatment for goodwill has a meaningful effect on the market for corporate control.

Keywords: Goodwill, mergers and acquisitions, buyout premia, structural modeling

JEL Classification: D44, G32, G34, M40, M41