Could a Change to the Goodwill Rule Boost Private Equity?

Accountants have been wringing their hands for decades over how to treat a business’s goodwill—the value of customer loyalty, human capital, and synergies—when a company changes hands. Should it be allowed to sit on the books perhaps indefinitely, or should an acquirer write it off over a defined period of time?

The issue has been a hot potato for years, and research explains why the stakes are high: Currently the carrying value of goodwill is tested each year for impairment to determine whether its fair value has decreased. Changing the rules to require that buyers amortize, or gradually expense, goodwill over 10 years would slash buyout prices, dramatically shrink the $1.6 trillion-a-year US mergers and acquisitions market, and push more businesses into the arms of private-equity buyers, according to Rice University’s Stefan J. Huber and Chicago Booth’s Charles McClure.

Goodwill, formally defined as the difference between the purchase price of a business and the fair value of the net identifiable assets acquired, typically accounts for almost half of US corporate deal values, according to the researchers. As the largest share of the purchase price paid in corporate mergers, it can significantly impact the amount an acquirer is willing to pay, they write.

The Financial Accounting Standards Board, the 51-year-old private standard-setting organization for US companies, had not long ago been considering a change for the accounting of goodwill. For almost 20 years, it has held that goodwill isn’t subject to amortization but should be tested annually for impairment that could force a write-down. Research in 2012 by Oxford’s Karthik Ramanna and MIT’s Ross L. Watts suggested that the FASB's 2001 ruling “was the result of political pressure” from businesses that preferred the impairment approach, Huber and McClure write.

In 2018, the FASB revisited the issue and considered whether to revert back to requiring companies to amortize goodwill over 10–25 years. It dropped the idea in 2022, with FASB chairman Richard Jones citing the magnitude of the change and uncertainty about the impact.

To better understand that impact, Huber and McClure built a model based on 861 all-cash deals involving takeover auctions of publicly traded companies from July 2001 through September 2022. They make a distinction between strategic bidders—such as competitors, customers, or suppliers seeking to increase earnings—and financial bidders, such as private-equity funds, which prioritize maximum cash flow.