Determinants of initial goodwill overstatement in affiliated and non‐affiliated mergers

• Author: Moonchul Kim,Youngsoon S. Cheon,Sunghee Ahn
• DOI: http://doi.org/10.1111/jbfa.12442
• Date: 01 May 2020
• Published date: 01 May 2020

DOI: 10.1111/jbfa.12442

Determinants of initial goodwill overstatement

in affiliated and non-affiliated mergers

Sunghee Ahn1Youngsoon S. Cheon2MoonchulKim3

1Catholic University of Korea,Bucheon, Republic

of Korea

2College of Business & Economics, Chung-Ang

University, Seoul, Republic of Korea

3School of Management, KyungHee University,

Seoul, Republic of Korea

Correspondence

YoungsoonS. Cheon, College of Business & Eco-

nomics,Chung-Ang University, 84 Heukseok-ro,

Dongjak-gu,Seoul, Republic of Korea.

Email:yscheon@cau.ac.kr

Abstract

This study examines the determinants of goodwill overstatement at

the time of mergers in a Korean setting. In the Korean M&A market,

there are two types of mergers: mergers between independent

companies (non-affiliated mergers) and mergers between compa-

nies under common control (affiliated mergers). This study extends

the literature by examining the factors likely to cause goodwill

overstatement in both types of mergers. The results reveal that

in affiliated mergers, goodwill at the time of a merger tends to be

overstated when controlling owners have higher equity ownership

in the target than in the acquirer. By contrast, information uncer-

tainty in the target value causes initial goodwill overstatement in

non-affiliated mergers. We also find that monitoring of independent

institutional investors with concentrated holdings against overpay-

ing for the target is more pronounced when controlling owners in

affiliated mergers have incentives to overpay for the target. In affil-

iated mergers, acquirers tend to write off goodwill more frequently

when controlling owners have higher equity ownership in the target

than in the acquirer. In non-affiliated mergers, information uncer-

tainty in the target value is significantly associated with subsequent

goodwill write-offs. These results suggest that the type of merger

has important consequences for initial goodwill recognition and

subsequent impairment.

KEYWORDS

affiliated merger, controlling owners, determinants of goodwill,

goodwill impairment, goodwill overstatement, information uncer-

tainty,institutional investors, non-affiliated merger

JEL CLASSIFICATION

M4

J Bus Fin Acc. 2020;47:587–614. wileyonlinelibrary.com/journal/jbfa c

2020 John Wiley & Sons Ltd 587

588 AHN ET AL.

1INTRODUCTION

Goodwill and goodwill impairment have been important issues in accounting research because of the significance

of goodwill in balance sheets1and subjectivity of assessing the fair value of goodwill. Moreover, overpaying for

a target firm at acquisition may lead to goodwill overstatement and subsequent impairment (Gu & Lev, 2011; Li,

Shroff, Venkataraman,& Zhang, 2011), and thus understanding the determinants of initial goodwill overstatement is

important.

The Korean mergers and acquisitions (M&A) marketprovides a unique opportunity to explore diverse theories that

may explaininitial goodwill overstatement. In Korea’s M&A market, there are two types of mergers. One type includes

mergers between independent companies (non-affiliated mergers), in which the acquirers may face information

uncertainty about the target value. Prior research suggests that the greater the uncertainty in the target value, the

greater is the overpaymentfor the target (Hansen, 1987; McNichols & Stubben, 2015). Hence, goodwill overstatement

in non-affiliated mergers is likely to be related to information uncertainty in the target value.

The other type of merger includes those between companies that are under common control (affiliated mergers)

such as mergers between chaebol-affiliated firms. In affiliated mergers, information uncertainty in the value of the

acquired firm may not be an issue because the same owners control both the acquirer and the target and have full

access to information about both firms. Hence, information uncertainty in the target value may not explain goodwill

overstatement in affiliated mergers, but there may be different incentives in these mergers to overstate goodwill. In

most business groups, controlling shareholders with highly concentrated ownership have power over affiliated firms

that exceedstheir cash flow rights. This discrepancy between control and cash flow rights gives controlling sharehold-

ers incentives to expropriate minority shareholders (Johnson, La Porta, Lopez-de-Silanes, & Shleifer,2000; La Porta,

Lopez-de-Silanes, & Shleifer,1999).

Even in mergers between affiliated firms, controlling shareholders havesimilar incentives to exploit minority share-

holders by transferring resources from one firm to another. The recent case of the merger between two Samsung

Group firms (Samsung C&T and Cheil Industries Inc.) illustrates how controlling shareholders can structure a merger

between affiliated firms to their best interest. In late May 2015, Samsung C&T announced a plan to merge Cheil Indus-

tries Inc. The plan proposed to offer 0.35 of a new share of Cheil Industries Inc. for everySamsung C&T share. However,

experts and outside shareholders of Samsung C&T argued that Samsung C&T shares were undervalued in the deal.2

Bae, Kang, and Kim (2002) also find negative market reactions to the announcements of acquisitions among chaebol-

affiliated firms, suggesting that acquisitions among these firms exploitminority shareholders. These observations sug-

gest that controlling owners have incentives to transfer wealth from the acquirer to the target by overpayingfor the

target when they havehigher equity ownership in the latter,which in turn leads to initial goodwill overstatement.

Takentogether, the factors driving initial goodwill overstatement may differ by the type of merger; information

uncertainty in the target value is likely to explain initial goodwill overstatement in non-affiliated mergers, whereas

controlling owners’ incentives to exploit minority shareholders are likely to explain goodwill overstatementin affili-

ated mergers. This indicates that the type of merger (affiliated versus non-affiliated) has important consequences for

initial goodwill recognition and subsequent impairment.3However,these consequences have not been studied in past

research, which has focused mostly on economic determinants and earnings management incentives. Thus, our study

fills this void by examiningthe determinants of initial goodwill overstatement and subsequent impairment by the type

of merger.

Our study also provides implications for initial goodwill recognition and subsequent impairment in other countries

where family-controlled firms exist.La Porta et al. (1999) show that 30% of their sample firms drawn from 27 countries

1Hayn and Hughes (2006) show that goodwill on averageaccounts for 10.7% of total assets in 1988 for the firms in Compustat and that this proportion had

increasedto 16.8% by 2001.

2TheKorea Herald, “Samsung Merger Faces Challenge”, June 4, 2015, http://www.koreaherald.com/view.php?ud =20150604001024&ACE_SEARCH =1.

3Prior research investigatingthe determinants of goodwillimpairment suggests thatsubsequent goodwillimpairment is relatedto overpayment for targets

atthe time of acquisition (Gu & Lev, 2011; Henning, Lewis, & Shaw,2000; Li et al., 2011).