Profitability of Corporate Acquisitions and the Acquisition Premium and Goodwill

Abstract

We examine the unresolved questions of whether corporate acquisitions create synergistic gains in the form of post-merger abnormal operating performance and whether the accounting goodwill is associated with post-merger operating performance. By disentangling the purchase accounting effect, we propose an adjusted cash flow performance measure to be used consistently over the pre- and post-merger periods. Using the adjusted performance measure and difference-in-difference approach, we reconcile the conflicting results from prior studies (Healy, Palepu, and Ruback, 1992; Ghosh, 2001). We document evidence that post-merger operating cash flow performance of the merged firms increases in comparison with the control firms matched by pre-merger performance and size. We also find that the size of the accounting goodwill and acquisition premium varies directly with post-merger operating performance. Such evidence suggests that acquiring firms which pay higher acquisition premium experience a corresponding higher cash flow return following the corporate acquisition and that the accounting goodwill represents future benefits.