Valuation effects of tax-deductible goodwill

This study examines empirically the valuation effects of tax-deductible goodwill to ascertain whether analysts and investors make certain adjustments to financial statement information to discriminate between tax-deductible and non-tax-deductible goodwill. Unlike goodwill amortization for financial reporting, which is a non-cash expense, tax-deductible goodwill provides cash savings for acquiring firms and may provide relevant information to assess firm value. To explore the valuation effects of tax-deductible goodwill, an algorithm was developed that considers the effects on equity and earnings when a portion of the goodwill amortization is tax-deductible. The algorithm is incorporated into an empirical specification of the Ohlson model to ascertain the effects of tax-deductible goodwill on firm value.; The evidence suggests that adjustments are made to equity and earnings when a portion of the goodwill amortization is tax-deductible. This implies that the cash savings associated with tax-deductible goodwill are incorporated into value and those adjustments for tax-deductible goodwill provide incremental, value-relevant information relative to the unadjusted valuation model. Given the complexity in determining goodwill tax effects, this result illustrates the sophistication of the markets and its ability to extract relevant information from financial statements for a limited number of firms.