Economic consequences of bargain purchase gains under ASC 805: evidence from banking industry

Abstract

ABSTRACT I examine whether bargain purchase gains (previously known as negative goodwill) reported under FASB’s Accounting Standards Codification 805, Business Combinations (ASC 805) in FDIC-assisted transactions represent economic gains to the acquiring banks and thereby qualify as part of banks’ Tier 1 capital. In a sample of 135 publicly-held U.S. banks that acquired failed banks in the period January 2009-April 2012, I find that bargain purchase gains are positively associated with acquirers’ future stock market and operating performance. Also, bargain purchase gains appear to capture expected future gains, including and beyond the FDIC subsidy. Specifically, the component of bargain purchase gains that is less likely related to the FDIC subsidy is positively associated with acquirers’ future short-run and long-run stock market performance and accounting operating performance. Finally, the factors, such as agency problem, internal control strength, and corporate governance strength, that affect the reliability of financial reporting matter for the reliability of bargain purchase gain estimation. Overall, the results imply that fair value accounting as implemented under ASC 805 enables bargain purchase gains to reliably reflect expected future economic gains, rather than measurement error or agency problem.