American Accounting Association 2006 Midwest Region Meeting March 30 – April 1 Chicago, Illinois

Friday, March 31, 10:20 a.m.-12:00 noon
Concurrent session 2B - Business Combinations (Financial Accounting and Reporting)

Title: Market Reaction to Accounting Regulatory Changes: Adoption of SFAS 142

Stephen C. Gara Drake University

ABSTRACT: This study examines the market reaction following announcements from the Financial Accounting Standards Board (FASB) that it intended to eliminate the requirement to amortize purchased goodwill (SFAS 142). SFAS 142 altered the long-standing treatment for purchased goodwill, ratable amortization, and replaced it with impairment testing. Consequently, reported earnings are no longer subject to the drag of amortization expense. While goodwill is still recognized and capitalized, it is now subject to annual impairment testing, potentially requiring large, but infrequent, write-downs of goodwill value. The rationale for the change was three-fold: to improve the quality of reported earnings, increase the comparability of U.S. accounting principles with those of other industrialized nations, and to mitigate the elimination of the pooling method for acquisition reporting. However, criticisms of SFAS 142 have been raised as well. The overall research question to be answered by this study is whether investors and other market participants consider the elimination of goodwill amortization to be a positive event, as evidenced by their changing assessment of firm value. An event study methodology is used to examine the market reaction associated with the adoption of SFAS 142 by the FASB, including the association between market reaction and the magnitude of reported goodwill. Additionally, consistent with Myring et. al. (2003), the debt contracting and political cost hypotheses are examined as contributors to the market’s reaction to SFAS 142. While, a negative reaction is found surrounding the FASB’s originals proposal shortening the goodwill amortization period from 40 to 20 years. The overall results indicate a positive market reaction for the initial event dates surrounding the FASB’s decision to eliminate amortization and impose impairment testing instead, though no significant reaction was found for the final vote by the FASB implementing SFAS 142. Finally, the reaction was generally positively associated with the reported level of goodwill.

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