Statement of Financial Accounting Standards No. 141 (SFAS 141) requires that acquirers in a business combination recognize the fair values of identifiable assets and liabilities acquired, with any excess of the purchase price over the fair value of identifiable net assets allocated to goodwill. In addition, the standard requires the disclosure of detailed information on the individual assets and liabilities acquired in material business combinations. The FASB believes that additional information on the assets acquired and liabilities assumed in business combinations “should, among other things, provide users with a better understanding of the resources acquired and improve their ability to assess future profitability and cash flows” (FASB 2002) This study examines whether the disaggregated information provided by purchase price allocations (PPAs) is, in fact, incrementally informative to investors by analyzing stock price responses to the release of the SEC reports in which the PPAs are initially disclosed. Thus, I assess the informativeness of PPAs by measuring, through stock returns, investors’ apparent reliance on them.
I expect a significant association between abnormal returns upon the filing of the SEC reports where the PPAs are first disclosed and the amount of merger consideration if the information provided in a PPA about the individual assets and liabilities acquired causes investor to revise (either upward or downward) their assessment of the resources obtained (or, equivalently, the cash flows likely to be realized) in exchange for the consideration.
I also compare the informativeness of PPAs made under APB 16 with those made under its replacement, SFAS 141. Because SFAS 141 imposes more detailed rules on how acquirers approach the PPA process, including explicit criteria for the separate recognition of intangible assets apart from goodwill, the comparison sheds light on the enduring question of whether greater regulation of managers’ accounting choices enhances or hinders their informativeness.
To provide further insight on the role that separate identification of assets has on the informativeness of PPAs, I analyze whether investors’ reliance on PPAs depends on whether the PPAs are dominated by goodwill. Because goodwill has multiple sources, which are not readily determinable, while separately recognized assets are more readily interpreted, I am interested in whether PPAs that are dominated by goodwill are less informative to investors. This examination is particularly important given that the FASB, as part of its deliberations on the June 2005 Exposure Draft of a standard to replace SFAS 141, considered and solicited input on the question of whether the separate recognition of intangible assets apart from goodwill was decision-useful (FASB Board Meeting Minutes, September 21, 2006).
For a sample of 570 economically significant mergers, I document a positive association between the absolute value of cumulative abnormal returns surrounding the release of the 10-Q or 10-K containing the first disclosure of the PPA and the value of consideration paid by the acquirer. This evidence is consistent with the PPAs contained in the SEC filings leading investors to reassess the value of resources gained in exchange for the consideration paid. I find that the investor response to the release of PPAs is less pronounced as institutional ownership increases, suggesting that institutional investors anticipate the information contained in the PPAs prior to their formal release in the SEC filings. This finding is consistent with evidence provided by Balsam, Bartov and Marquardt (2002) that institutional investors appear to anticipate information contained in quarterly filings related to earnings quality prior to their actual release dates. I also find that investor response to the release of PPAs is less pronounced for transactions involving firms in the same industry. Given that transactions between firms in the same industry are associated with less uncertainty, this finding suggests that the informativeness of PPAs to investors increases in the degree of prior uncertainty surrounding the merger.
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Do Investors Rely on Purchase Price Allocation Disclosures?
