Accounting Discretion

This study investigates the factors affecting acquirers’ allocation of purchase price between goodwill and identifiable intangible assets with finite lives. SFAS 142 replaces goodwill amortization with periodic impairment tests that are based on fair value estimates, while most identifiable intangible assets are still amortized over finite useful lives. As a result of the differential accounting treatment, we predict that management is motivated to allocate more purchase price to goodwill when 1) they benefit from reducing amortization expenses or maintaining a strong balance sheet, and 2) they are capable of avoiding future goodwill impairment losses by managing the fair value estimate of goodwill. After controlling for the economic determinants of the allocation decision, we find that an acquirer with greater flexibility in goodwill impairment assessment allocates more purchase price to goodwill. The explanatory power of the acquirer characteristics that capture management opportunism is at least as large as that of the economic determinants. Furthermore, given the total amount of goodwill allocated, acquirers with multiple segments tend to allocate more goodwill to the relatively more profitable segment(s). The results suggest that unverifiable accounting measures likely deviate from the underlying economics as a result of management exploiting their accounting discretion. * We thank Ross Watts, Jerry Zimmerman, and seminar participants at HKUST for their helpful comments and suggestions. We also thank Fang Wan for her excellent research assistance. All errors are our own.