Within corporate accounting, acquisitions includes two concepts that I will focus on: acquisition premium and goodwill on acquisition. Mergers and acquisitions deal with the combining of companies, i.e., mergers, or the purchase of one firm by another, i.e., acquisition. Our concepts are understood within this theoretical context.
Acquisition premium refers to the difference between the real value of a company and the actual price paid for the company upon a merger or acquisition. The firm stands a certain value before it is purchased. However, the buyer often pays a price higher than the real value. The increased amount, from real value to purchase price, constitutes the “acquisition premium.” However, this premium is not necessary. The buyer does not have to pay above the real value of a company in all situations. Sometimes, they may even pay less.
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"Acquisitions: Premium and Goodwill".
Who determines the “real value” and offer price during an acquisition? As Shroff, Venkataraman & Zhang note (2011, p. 748), the buyer decides both values. Let’s consider an example in order to flesh out these concepts. LG decides to buy Samsung. So, LG will research and calculate a value of the Samsung corporation, which equates to how much the company is worth based upon a host of variables. Then LG would determine an offer. That is, the amount they are willing to pay for Samsung. The offer price usually exceeds the calculated real value and is intended to make the buyer’s bid attractive. If Samsung’s actual value decreases after LG’s initial bid, thus increasing the acquisition premium, LG can withdraw their offer. With some clarity on the concept of acquisition premium, let’s develop the idea of “goodwill acquisition.”
“Goodwill” in an acquisition refers to the intangible assets of the purchased company. Employee relations, customer relations, brand name and reputation, plus any patents or technological distinctives form the goodwill of a company. All goodwill is not necessarily good. A company may have poor customer relations or hold a brand name with little reputation among competitors. On the other hand, goodwill can represent an enormous value for a company. Take for example, Sony Corporation (Wu & Zhang 2010)—the name alone carries familiarity, longevity, and high quality. Therefore, such a brand might drastically increase the value of a company.
How does goodwill fit with the acquisition premium? Typically, the purchaser considers the goodwill of a company as the primary set of variables for determining the acquisition premium. Thus the real value derived from tangible assets must increase, or decrease, based upon the intangible, “goodwill acquisition” of the purchased firm. However, buyers account for other matters too, such as costs, when offering a purchase price for a company. Thus, goodwill and acquisition premium do differ.
Measuring the goodwill of a company is largely subjective and situational. First, it depends upon the values of the buying company. If they do not care to attract a certain clientele that their purchased company specializes in, then the company’s former success in reaching that clientele will not constitute a high level of goodwill. Second, goodwill depends upon the situation, especially the current state of the market, a pattern we see supported by historical examples (Wootton, Wolk, & Norman, 2011). If a buyer aims to purchase a new company, and that company’s greatest competitor, with an historical, successful brand name, has recently gone bankrupt, then the new company becomes much more attractive and increases in goodwill value. The goodwill of a company finds similarities and differences with acquisition premium. While we have only briefly considered each, they depend upon the posture of the buyer and a variety of contextual factors. This expands the study of acquisitions towards new questions, such as acculturation between companies (Nahavandi, 1988).
- Li, Z., Shroff, P. K., Venkataraman, R., & Zhang, X. (2011). Causes and consequences of goodwill impairment losses. Review of Accounting Studies, 16(4), 745-778.
- References
Nahavandi, A. (1988). Acculturation in Mergers and Acquisitions. The Academy of Management Review, 13(1), 79–90. - Wootton, C.W., Wolk, C.M., & Norman, C. (2003). An historical perspective on mergers and acquisitions by major US accounting firms. Accounting History, 8(1), 25–60.
- Wu, J.S. & Zhang, I. (2010). Accounting integration and comparability. Working paper. University of Rochester and University of Minnesota.
