The nature and implications of acquisition goodwill^*

We investigate the conditions under which the accounting-based acquisition goodwill represents an economic asset. Analysis of the stock market reaction to 2123 acquisitions suggests that although investors perceive 41% of the acquisitions to have a negative net present value consistent with overpayment for the target, the acquirer records positive accounting goodwill. Adjusting the goodwill to eliminate any overpayment results in a better prediction of future operating performance. As a thought experiment, we also increase the recognized accounting goodwill for the remaining 59% of the sample. Again, we show that this goodwill construct is a better predictor of future operating performance.