A new approach to evaluate M&A prices and to predict goodwill impairments

• In Event: Valuation

Abstract

This study introduces a new method for evaluating mergers and acquisitions (M&As) and goodwill impairments associated with them. With the new method which utilizes the residual-earnings model, I estimate the steady-state stand-alone value of a target and argue that the remainder of the purchase price is paid for the expectations on a target’s earnings growth. Then, I document that the expectations on a target’s earnings growth in M&A purchase prices are (1) negatively related to the acquirer's long-term returns, (2) positively associated with future goodwill impairments, and (3) superior to event-date market reactions and premiums in predicting long-term returns and goodwill impairments. These findings imply that the new method provides an ex-ante useful measure to evaluate M&A deals.

Author

• Hyung il Oh, University of Washington Bothell