Accounting Discretion and Purchase Price Allocation after Acquisitions

This study investigates acquirers’ allocation of purchase price between goodwill and identifiable intangible assets upon the completion of acquisitions. SFAS 142 replaces goodwill amortization with periodic impairment tests based on fair value estimates, while most identifiable intangible assets are still amortized over finite useful lives. As a result of the new differential accounting treatment, we predict and find that managers allocate more purchase price to goodwill post SFAS 142 to reduce amortization expenses when they anticipate greater discretion in future goodwill assessment to avoid reporting impairment. We also find that older CEOs who likely care more about short-term accounting earnings and bonus record more goodwill to avoid amortization expenses. The results are robust to controls for the economic determinants of the allocation. The explanatory power of acquirer/CEO characteristics that capture managers’ reporting incentives is greater than that of the economic determinants. In contrast, these variables cannot explain the purchase price allocation prior to SFAS 142. The findings suggest that unverifiable accounting measures likely deviate from the underlying economics as a result of management exploiting their accounting discretion. We also explore the role of external appraisers in the post SFAS 142 period and find mixed results. * We thank Hemang Desai, Mary Barth, Rebecca Hann, Clive Lennox, Ross Watts, Jerry Zimmerman, and seminar participants at the AAA 2007 Financial Accounting and Reporting Section (FARS) meeting, the University of Minnesota Mini Conference on Empirical Research, HKUST, and the University of Southern California for their helpful comments and suggestions. We also thank Fang Wan and Junqi Zou for their excellent research assistance. All errors are our own.