Campbell_FairValueBusinessCombinations
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Campbell_FairValueBusinessCombinations
Evidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationslton.uark.eduJohn L. Campbell* Tern,- College of Business University of Georgia johnc@uga.eduJonathan E. Shipman Walton College of Business University of Arkansas jshipman ijwalton.uark.eduZac Wiebe Walton College of Business University of Arkansas zwiebe@walton.uark.edu43831* Corresponding Author: Campbell_FairValueBusinessCombinationsA3 29 Moore-Rooker Hall. Athens. GA. 30677. phone: 706-542-3595. email: johnc@uga.edu. We thank Kris Allee. Coty Cassell. Manin Fiscus. Santhosh RamalCampbell_FairValueBusinessCombinations
ingegowda. and workshop participants at the University of Arkansas for helpfill comments and suggestions. John Campbell gratefully acknowledge financiEvidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationsledges financial support from the Garrison Wilson Endowed Chair in Accounting from the Sam w Walton Business School at the University of Arkansas.Evidence on the Decision Usefulness of Fair Values in Business CombinationsAbstract: Whether fair value measurement provides decision-useful information i Campbell_FairValueBusinessCombinationss one of the most debated accounting questions in recent history. Although ASC 805 requires that identifiable acquired assets and assumed liabilitiesCampbell_FairValueBusinessCombinations
in business combinations be measured at fair value, little is known about the decision usefulness of fair values in this context. In this study, we exEvidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationsinformation in decision making. Our results suggest that fair values have predictive ability for post-deal casli flows beyond that of combined pre-deal book values and earnings. However, this finding only holds in horizontal (same-industry) deals, deals that do not involve intangibles-intensive targ Campbell_FairValueBusinessCombinationsets, and deals in which managers have less incentive to inflate goodwill. We also find that analysts update their cash flow forecasts in a pattern thaCampbell_FairValueBusinessCombinations
t suggests they detect and rely on the signals that deal characteristics provide about limits on the decision usefulness of fair values. Our findings Evidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationsnd the limitations of fair value measurement for non-financial assets and liabilities.Keywords: Fair Value; Mergers and Acquisitions; Business Combinations; Cash Flows; Analyst ForecastsData Availability: All data used are publicly available from sources cited in the text.1. IntroductionWhether faữ Campbell_FairValueBusinessCombinationsvalue accounting provides decision-useful information is one of (he most debated questions in recent history among accounting standard setters, practiCampbell_FairValueBusinessCombinations
tioners, and academics. Central to the debate arc (he concepts of relevance and faithful representation defined in the FASB’s Conceptual Framework (CoEvidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationsement involves substantial uncertainty and discretion, and fair values are not always reliably estimable. U.S. GAAP uses a mixed-attribute measurement system under which subsequent measurement for most assets is based on historical cost (less cost recovery), while certain other assets and liabilitie Campbell_FairValueBusinessCombinationss, including financial instruments, are measured at fair value. While prior research suggests that the fair values of financial instalments may providCampbell_FairValueBusinessCombinations
e incremental decision-useful information beyond costs, less is known about the relevance and representational faithfulness of the fair values of non-Evidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationslities under GAAP is in business combinations. Under SFAS 141 and 141R(ASC 805). the previously recognized assets and liabilities of an acquired entity are revalued from book value to fair value, and identifiable intangible assets that were previously unrecognized by the target arc recorded on the a Campbell_FairValueBusinessCombinationscquirer's balance sheet al fair value, hl large public mergers and acquisitions (X'f&As) this process involves complex estimates and judgments, and itCampbell_FairValueBusinessCombinations
can result in a substantial change in the mix of cost and fair value on linns' balance sheets.2' Prior research on fair value accounting for non-finaEvidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinations commonplace outside of the context of financial instruments (see Cotter and Richardson (2002) for a summary). For a summary of prior research on fair value accounting for financial instruments under U.S. GAAP, see Song. Thomas, and Yi (2010).Throughout the paper, we use the more colloquial term “M& Campbell_FairValueBusinessCombinationsA" and the term "Business Combination" (as codified in ASC S05) interchangeably.1Although SFAS 141 explicitly states that fair value measurement in buCampbell_FairValueBusinessCombinations
siness combinations should provide additional decision-useful information about acquired assets and liabilities beyond that provided by book values, tEvidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationsts and the ability of fair values to provide relevant information about acquired assets and liabilities.3 Consistent with those concerns, several characteristics of M&As could plausibly inhibit the decision usefulness of fair values. First, fair value estimation is atypically challenging because M&A Campbell_FairValueBusinessCombinationss involve inherent information asymmetry (Erickson. Wang, and Zhang 2012; Raman. Shivakumar. and Tamayo 2013). considerable uncertainty regarding asseCampbell_FairValueBusinessCombinations
t values (Skaife and Wangerin 2013: McNichols and Stubben 2015: Wangerin 2019). and complex estimates that present challenges for managers and externaEvidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationses for non-financial assets (Barth and Clinch 1998: Aboody, Barth, and Kasznik 1999: Muller and Riedl 2002). Finally, prior research suggests that managers have incentives to distort fair values in M&A purchase price allocations (PPAs) in order to over-allocate purchase price to goodwill (Shalev. Zh Campbell_FairValueBusinessCombinationsang, and Zhang 2013). Thus, although the stated intent of SFAS 141 was to improve the usefulness of financial reporting, whether, and if so, under whaCampbell_FairValueBusinessCombinations
t circumstances, fair values assigned to identifiable assets and liabilities provide decision-useful information in business combinations and whether Evidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationsulness of fair values using a hand-collected sample of 650 M&As involving U.S. public companies between 2003 and 2017. Because•' Opponents of SFAS 141 questioned their ability to reliably measure the fair value of intangible assets and argued that the cost of measuring individual fair values would o Campbell_FairValueBusinessCombinationsutweigh the benefit. (FASB 2001; Koib and Vermeer 2001).2most assets and liabilities acquired in business combinations are remeasured at fair value puCampbell_FairValueBusinessCombinations
rsuant to ASC 805, and because of the magnitude of the U.S. M&A market, which according to Levine (2017) accounts for more than SI trillion in investmEvidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationsor research provides evidence on the decision usefulness of goodwill in U.S. M&As (e.g., Henning, Lewis, and Shaw 2000, Shalev et al. 2013, Paugam, Astolfi, and Ramond 2015). our study is unique in that we focus on the fair value measurement decisions (regarding identifiable assets and liabilities) Campbell_FairValueBusinessCombinationsthat determine the allocation of residual purchase price to goodwill.4To examine the decision usefulness of fair values in business combinations, we bCampbell_FairValueBusinessCombinations
egin by following a long line of research on the predictive ability of accounting information for future cash flows.5 As discussed in Concepts StatemeEvidence on the Decision Usefulness of Fair Values in Business CombinationsJustin Blann Walton College of Business University of Arkansas j blann@wa l Campbell_FairValueBusinessCombinationstainty of future cash flows. SFAS 141 references Con. 8 directly, stating that an important element of decision-useful information is the ability to predict future cash flows, and concluding that fair values in business combinations “reflect the expected future cash flows associated with acquired as Campbell_FairValueBusinessCombinationssets and assumed liabilities" (p. 45. FASB 2001). Considering that intention, we model post-deal cash flows as a function of the pre-deal income and bCampbell_FairValueBusinessCombinations
ook value of both the target and* Goodwill is calculated as the excess of the purchase price over the fair value of net identifiable assets, and it isGọi ngay
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