The Nature and Implications of Acquisition Goodwill

We investigate the conditions under which the accounting‐based acquisition goodwill disclosed by U.S. filers appropriately represents an asset to the firm — specifically, whether accounting - based acquisition goodwill is representationally faithful to the underlying economics of the transaction as required under the FASB’s conceptual framework. Analysis of financial statements for a sample of 2,123 merger transactions completed during 2002 — 2006 suggests that although 41% of these transactions have a negative net present value, the acquirer did not write‐off goodwill at the time of acquisition as required under U.S. GAAP. When we adjust the recorded goodwill to be consistent with SFAS #141, we find that it is a better predictor of future operating performance. As a thought experiment, we also adjust recognized goodwill for the other 59% of the sample with positive net present value acquisitions to reflect the estimated fair value of goodwill and similarly find that this goodwill construct is also a better predictor of future operating performance than recognized acquisition accounting goodwill.