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Higher quality 6” x 9° black and white photographic prints are available for any photographs or illustrations appearing in this copy for an additional charge. Contact UMI directly to order. ProQuest Information and Learning 300 North Zeeb Road, Ann Arbor, Mi 48106-1346 USA 800-521-0600 UMI ® GOODWILL: CHARACTERISTICS AND IMPAIRMENT by Natalie Tatiana Churyk Bachelor of Science California State University, Long Beach, 1993 Master of Business Administration California State University, Long Beach, 1997 Submitted in Partial Fulfillment of the Requirements for the Degree of Doctor of Philosophy in Moore School of Business University of South Carolina 2001 TNarncbec sh, Cotter. Co-Director of Dissertation AL eu Committee Member Dean of The Graduate School UMI Number: 3036190 Copyright’2001 by Churyk, Natalie Tatiana Ali rights reserved.
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Box 1346 Ann Arbor, MI 48106-1346 © Copyright by Natalie Tatiana Churyk, 2001 All Rights Reserved. ii To my family Hi Acknowledgements [ would like to thank Gene Chewning, Maribeth Coller, LeRoy Brooks, McKinley Blackburn, Earl Spiller, and all the other faculty and staff at the University of South Carolina for making this possible. I would like to thank John Lacey for leading me in the direction of a Ph. I would like to thank Dr.
G, Patricia Lynch, and Khosrow Moshirvaziri for keeping my spirits up throughout the program. I would like to thank Lisa Benaise for being a wonderful friend for the past twelve years. [ would like to thank my classmates Karen Epermanis, Larry Seese, Sue Swanger, Julia Higgs, and Tong Yu for giving their guidance. Lastly, I would like to thank everyone at CBC including Doris, Tracey, Paul, Joyce, Jane, and Ruby.
iv Goodwill: Characteristics and Impairment Abstract The Financial Accounting Standards Board (FASB) issued two statements in June 2001 related to goodwill: Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. 142 requires an annual review for goodwill impairment.
This review should be conducted more frequently in certain circumstances. The circumstances described in SFAS No. 142 include a subset of the circumstances discussed in the Exposure Draft (ED), Business Combinations and Intangible Assets (FASB, 1999). I structure my analysis around the ED discussion in order to provide a more comprehensive analysis of the items the FASB initially considered to be important.
This analysis also sheds light on whether the final statement includes relevant concerns and on how it may be implemented in practice. Goodwill has been the subject of research since the early 1900’s, but the focus of this research has been on how to define, record, and subsequently treat goodwill rather than on the economic determinants of goodwill or how it might become impaired. This study will examine these latter two issues pertaining to goodwill. First, | examine the characteristics comprising goodwill by regressing goodwill on a number of acquired-firm characteristics proposed by the FASB and researchers as determinants of goodwill.
This analysis provides evidence on which characteristics are related to higher premiums paid by purchasing firms. Findings indicate that both statutory-based assets and corporate organizational and financial assets are significantly positively related to goodwill. Second, I examine the initial overpayment for goodwill due to agency conflict and/or hubris where these are identified by calculating cumulative abnormal returns around the announcement of the merger/acquisition for both the parent and the target. Findings indicate that synergy is predominant in the total sample, but that hubris is also present in a subsample.
To examine the effect that hubris may have on the initial valuation of goodwill, I regress goodwill on its characteristics and a variable representing agency conflict/hubris. It is important to determine if goodwill is initially overvalued rather than subsequently impaired, in order to have representationally faithful financial statements. Finally, [ examine the ED suggestions for evaluating the initial and subsequent impairment of goodwill by including a dichotomous variable indicating the occurrence of an impairment event in two different models. The first model regresses goodwill on characteristics comprising goodwill and the event variable.
This model shows that goodwill is not initially impaired. The second model regresses the market value of equity on the book value of equity, the book value of goodwill, an impairment variable along with interactions, and an abnormal earnings variable. Results indicate that neither goodwill nor future firm earnings are impaired at acquisition. Subsequent impairment of goodwill arises when the parent’s book value of equity is greater than its market value of equity and when the parent’s stock prices decline significantly following the purchase.
This is the first study, to my knowledge, that examines events that impair goodwill. Balance sheets are not representationally faithful if impaired goodwill is not appropriately written down. The failure to write-down impaired goodwill violates vi conservative accounting practices. Firms can address this problem by implementing impairment evaluation measures.
vii Table of Contents Page xi xIH Chapter: 1: Introduction to Characteristics of Goodwill and its Impairment TA. on HH nh nh nh.2 Characteristics Comprising GoodwHl.3 Impairment of GoodwIll.4 Contribution of the Study. cu sa 2: Literature Review and Hypotheses Development.2 Characteristics Comprising Goodwlll.2a Customer-based/market-based assets.2b Contract-based assets.2c Technology-based assetS.2d Statutory-based assets.2e Workforce-based assets.2f Corporate organizational and financial assets.3 Initial Overpayment for Goodwill and Subsequent Impairment of Recorded Goodwill.3a Value-relevance of goodwill.3b Initial overpayment for goodwil. 27 Vill Table of Contents — continued Chapter Page 2.3¢ The FASB impairment guidelines at acquisition and subsequcnt to acquisition.
HH HH m kv v nai 35 3.1 Sample Selection-Total Sample.2 Existence of Synergy, Agency Conflict and/or Hubris.3 Characteristics Comprising Goodwill. chu nu nh ng ke 40 3.4 Initial Overpayment for and Initial Impairment of Recorded GoodwllÌ.Q HH k 43 Agency Conflict/Hubris Sample ___. 43 Initial Impairment Sample. 43 Table of Contents -continued Chapter Page Agency Conflict/Hubris Measure to be Included In the Model.
43 The FASB’s (1999) Impairment Guidelines .5 Subsequent Impairment of Goodwill. 50 4: Results For Characteristics Comprising Goodwill and Initial Overpayment for and Subsequent Impairment of Recorded Goodwill —.1 Descriptive Statistics and Multicollinearity Diagnostics .1a Descriptive Statistics for AlI Models.1b Descriptive Statistics Comparing the Parent Sample to the Population.2 Regression Results for Synergy, Agency Conflict and/ Or HubriS. HH HH nung 54 4.3 Regression Results for Characteristics Comprising GOOdWIÌÏ.4 Initial Overpayment for and Subsequent Impairment of Recorded Goodwill.4a Regression results for agency conflict/hubris using characteristlcs modeÌ_.4b Regression results for initial impairment using characteristics model.4c Regression results for initial impairment using a levels modeÌ. 58 Table of Contents -continued Chapter Page 4.4d Regression results for subsequent impairment using a levels modelÌ.
con sec 39 5: Implications and Conclusions. H vi HH HS KH Hi tin 62 Tables. Và nh nh hy ¬—. kgvn vn 82 Reference List.
¬— c2 H902 0V n1 HH tt mm va 3H ¬— 86 List of Tables Table Page 1. Identifiable Intangible Assets as Listed by the FASB in its Exposure Draft 67 2. Characteristics, Agency Conflict/Hubris and Impairment Potential Samples 3. Characteristics of Goodwill Variables, Compustat Mnemonic, Expected Sign, and the Hypothesis to Which the Variable Relates.
Agency/Hubris Hypothesis and Testable FASB Impairment Guidelines Measures, and Related Hypotheses. Descriptive Statistics - Characteristics, Agency Conflict/Hubris, Initial Inpairment, and Subsecquent Ímpairment. Descriptive Statistics Comparing the Sample to the Population Over the Sample Years 1996 — 1998. Pearson (Spearman) Correlations Above (Below) the Diagonal for Characteristics Comprising GoodwHl.
Pearson (Spearman) Correlations Above (Below) the Diagonal for Initial Impairment of GoodwH. Pearson (Spearman) Correlations Above (Below) the Diagonal for Subsequent [mpairment of GoodwlÌÏ. Agency Conflict/Hubris Regressions of Target Gain on Total Gain and Target Gain on Parent Gain as a Whole and as Positive and Negative Subsamples. Regression Results for All Characteristics Comprising Goodwill and Various Subsets of Characteristics Comprising Goodwill 78 12.
Regression Results for All Characteristics Model With Overpayment for Goodwill and Initial Impairment of Goodwill —. Regression Results for Initial Impairment of Goodwill Using a Levels Model =ee. Regression Results Subsequent Impairment Events. 81 Kil List of Abbreviations Rr.vi Adjusted r-squared @CAVG Average across a set @CHGCO Company transformation @SET Selected companies based on a condition ADV/XAD Advertising AE Abnormal earnings AR Abnormal return AT Total assets BORR Ratio of parent borrowing rate to target borrowing rate BVE Book value of equity BVLGW Book value of equity less purchased goodwill CASH/CHE Cash and equivalents CHE/CASH Cash and equivalents CVGM Parent carrying value is greater than parent market value DT Debt-total DTEQ Total debt/total equity EMP Number of employees GDWL Goodwill GEO Geographical location GWSIG Goodwill is significant compared to the purchase price HI Horizontal integration INTAN Intangible assets IALGW Intangible assets less goodwill IE Impairment event in general LAB Labor expense per employee compared to the industry LEV Ratio of parent debt-to-equity to target debt-to-equity MB Multiple bidders MT Managerial talent — ratio of target sales to industry sales MVE Market value of equity PCAR Parent cumulative abnormal return around purchase is negative PG Parent gain PREM Premium paid over target market value before acquisition discussions PS Parent used significant amount of parent shares for purchase payment R Return RATE Long-term credit rating compared with parent RD/XRD Research & development SALE Net sales SPD Stock price decline since purchase of target SPDRC S&P senior debt rating TA Total assets TARG Target gain TOTG Total gain TL/TLCF Tax loss carryforward TLCE/TL Tax loss carryforward xili List of Abbreviations - continued TR Tax rate VI Vertical integration XAD/ADV Advertising XINT Interest expense XLR Labor expense XRD/RD Research & Development XIV Chapter |: Introduction to Characteristics of Goodwill and its Impairment 1.1 Introduction A major focus of prior goodwill research has been on what goodwill represents.
For instance, goodwill has been interpreted as representing the value of expected excess future earnings discounted over a number of years (Walker, 1938; Emery, 1951; Nelson, 1953; Gynther, 1969; Ma and Hopkins, 1988). It also has been interpreted as a measure representing the difference between the fair values of the identifiable assets and the price paid for the firm as a whole (Emery; 1951; Miller, 1973; Colley and Volkan, 1988; Ma and Hopkins, 1988). Another interpretation views goodwill as representing a momentum or an initial push comprised of unrecorded characteristics/components such as managerial skill, economies of scale, and customer relations (Emery, 1951; Nelson, 1953; Barlev, 1973). Regardless of what goodwill is interpreted as representing, the Financial Accounting Standards Board (FASB) requires goodwill to be measured and recorded as the difference between the payment made for a firm and the fair value of its net identifiable assets.
The recorded amount does not explicitly reflect the characteristics comprising goodwill or take into account possible overpayment issues or subsequent impairment which may render the measurement of goodwill inaccurate. This study investigates three issues related to goodwill: (1) characteristics comprising recorded goodwill, (2) initial overpayment for goodwill, and (3) subsequent impairment of recorded goodwill.