Market Responses to Private and Public Targets: The Role of Goodwill Valuation

Abstract

Mergers and acquisitions (M&As) are an important aspect of corporate finance. To better understand the factors affecting market reactions to M&As, we examine market responses to M&As with private and public targets both at the time of announcement and after completion. Using a sample of over 1,500 M&As completed from 2002 to 2016, we find that investors tend to overprice the value of intangible assets acquired from a private target at the time of an M&A announcement but that the overpricing of goodwill is subsequently corrected in the years following the deal’s completion. We show that investors predict the decreasing value of goodwill and can promptly and efficiently adjust its pricing regardless of whether the impairments have been delayed, indicating that investors believe that acquired goodwill deteriorates regardless of goodwill impairment. We also provide evidence that Statement of Financial Accounting Standards (SFAS) 141(R) increases investors’ long-term valuations of other acquired intangible assets but negatively impacts goodwill’s market valuation after an acquisition. Our findings may be useful to the accounting standards setters in improving reporting guidelines related to goodwill and other intangible assets.