The Justifiability of Financial Reporting Preferences in Accounting for Intangibles in Business Combinations

Abstract

We test whether an impending change in the accounting for goodwill mitigates bias in the initial values that acquirers assign to intangible assets. Results of two experiments with experienced professional participants suggest that the new accounting alters, but does not eliminate, bias in acquisition-date fair values. Specifically, we provide the new insight that acquirers have a preference to minimize the value of recognized goodwill when the initial fair values assigned to intangibles do not affect future earnings, as under the planned accounting change. Further, this preference regarding the composition of the balance sheet appears to be specific to goodwill. Our research also complements previous archival evidence by providing causal evidence that acquirers are more likely to bias initial fair values when there is significant uncertainty in their private information about asset value. In contrast, a low level of uncertainty “psychologically ties acquirers’ hands” such that they do not bias their fair value estimates. Our theory and results provide important input to standard setters and practitioners regarding an unanticipated consequence of the impending change in accounting for intangible assets.