The Invisible Burden: Goodwill and the Cross-Section of Stock Returns

Abstract

We study the role of goodwill, an important form of intangible assets arising from past M&A histories, on asset pricing. We find that goodwill-to-sales strongly and negatively predicts the cross-section of stocks returns, especially among firms with cross-industry M&A histories and firms with overconfident CEOs. It remains as an economically and statistically significant predictor of stock returns after adjusted by all known factors. Our results suggest that goodwill-to-sales subsumes information on firm value, and stock markets underreact to this information because the fair value of goodwill is unobservable and hard to evaluate.