Assessing the Value of Growth Option Synergies from Business Combinations and Testing for Goodwill Impairment: A Real Options Perspective

Goodwill is an intangible asset, and therefore hard to measure and difficult to account for. This article argues that the two-stage impairment test for acquired goodwill under SFAS 142 has several limitations. Most important, it measures aggregate rather than acquired goodwill, making it very difficult to separate acquisition-related goodwill from aggregate enterprise goodwill after a business combination. As a consequence, any potential deterioration of acquired goodwill value could be concealed by increases in internally generated goodwill. As an alternative, the authors propose a real options approach to managing a business unit portfolio as a better framework for conducting the goodwill impairment test. A real options approach to testing goodwill for impairment—as opposed to the standard fair value assessment based on DCF analysis—not only accounts for deterioration in the value of goodwill, but also captures upward potential. It enables tracking of the changes in goodwill value from one period to the next, providing a less biased estimate of its real value at each point in time.