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Review of Accounting Studies

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01.12.2012

Evidence on the use of unverifiable estimates in required goodwill impairment

verfasst von: Karthik Ramanna, Ross L. Watts

Erschienen in: Review of Accounting Studies | Ausgabe 4/2012

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Abstract

SFAS 142 requires managers to estimate the current fair value of goodwill to determine goodwill write-offs. In promulgating the standard, the FASB predicted that managers will, on average, use the fair-value estimates to convey private information on future cash flows. The current fair value of goodwill is unverifiable because it depends in part on management’s future actions (including managers’ conceptualization and implementation of firm strategy). Agency theory predicts managers will, on average, use the unverifiable discretion in SFAS 142 consistent with private incentives. We test these hypotheses in a sample of firms with market indications of goodwill impairment. Our evidence, while consistent with some agency-theory based predictions, does not confirm the private information hypothesis.

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Prior to SFAS 142, goodwill was impaired only when certain associated long-lived assets were also impaired (SFAS 121); moreover, goodwill was also subject to periodic amortization (APB 17).

Our sample begins in 2003 because that was the first full-year of SFAS 142 adoption after the standard’s transition adoption year; our sample ends in 2006 because financial data beyond 2006 was not available when we initiated this study.

Of course, not all firms in our sample can be expected to take goodwill write-offs: our paper explores various reasons firms may avoid write-offs. Moreover, not all goodwill write-offs are expected to be in the sample with BTM > 1. Appendix 1 explores the association between goodwill write-offs and BTM status in a broad sample of firms. The absolute number of firms taking goodwill write-offs is higher when BTM < 1 than when BTM > 1, which suggests most goodwill write-off decisions are not on-the-margin vis-à-vis BTM. However, the frequency of firms taking goodwill write-offs is relatively more likely when BTM > 1 than when BTM < 1, suggesting it is reasonable to expect more write-offs when BTM > 1.

We use data from Thomson One Banker to follow up on the status of the remaining 28 sample firms (i.e., 124 − 96) that are dropped from the CRSP database in the post-sample year. A detailed analysis of these firms is available in Sect. 3. To summarize, most of these firms are acquired, delisted, or thinly traded; statistical comparisons within this subsample are precluded by the low n.

Avoiding timely impairments to prevent debt covenant violations can also be motivated by CEO reputation concerns (in addition to transferring wealth from debt holders to shareholders) since failure to do so can be perceived as managerial incompetence.

Unlike moral hazard implicit in valuing items like net accounts receivable (where subsequent management effort on collecting receivables is observable and can be entered into evidence), it is very difficult to make the case (in the event of ex post litigation) that goodwill losses were due to management inaction (rather than macroeconomic conditions). That is, the claim cannot be “objectively characterized as true or false” (Ollman v. Evans, 750 F.2d 970, D.C. Cir., 1984), the legal standard for verifiability.

Even in circumstances where GAAP rules may permit delayed write-offs, assuming the decline in market value is permanent, conservative auditors are likely to encourage managers to take timely write-offs when BTM > 1. Motivated by this premise, Ramanna and Watts (2007) study the goodwill write-off decisions among firms with 1 full year of BTM > 1. They find the frequency of non-impairment in that sample is 71 %. Further, they find goodwill non-impairment is associated with several agency–theory based motives and with proxies for firms’ ability to exploit the discretion in SFAS 142. They do not find evidence consistent with the private information hypothesis.

Firms that accelerated impairments into the adoption year to create write-off loss reserves are unlikely to be in our sample since we filter out firms without positive goodwill balances.

The number of firms with BTM_t−1 > 1 identified above, i.e., 382 firms, differs from that shown in Appendix 1, i.e., 425 firms, because the former is calculated with the additional restriction Goodwill_t−1 > 0.

Dichev and Skinner (2002) find that leverage is a relatively noisy proxy for the probability of debt covenant violation; however, holding constant this probability, leverage is likely a good proxy for the cost of debt covenant violation (the more debt a firm has, the more costly it will be to renegotiate contracts once covenants are violated). Further, we expect the probability of covenant violation in our sample (firms with 2 years of BTM > 1) is relatively high.

Once goodwill is allocated among reporting units, reallocation in future years is not permitted (SFAS 142, §34). Thus in principle, the “number and size of reporting units” provides flexibility only at the time of acquisition. Firms, however, can reorganize their reporting structures in future years (SFAS 142, §36), effectively leading to a reallocation in acquired goodwill.

In unreported tests, we find the VNA ratio has high in-sample variance; we also find relatively high kurtosis in this variable, suggesting the high variance is due to a few extreme observations. To mitigate the effect of such observations (and to avoid trimming-induced data loss in what is a relatively small dataset), we use in-sample ranks in computing UNA.

We tested this assumption for a random sample of ten firms by searching 10-K filings for impairments data. We found no instance where our assumption was inconsistent with data in the 10-K.

Throughout the paper, inferences based on raw returns are unchanged when using size-adjusted returns.

Specifically, the SFAS 121 sample consists of firms with fiscal years “t” ending between December 1996 and December 2000 that have (1) book goodwill, (2) equity-market-values greater than equity-book-values in t − 2, (3) BTM > 1 in t − 1, and (4) BTM > 1 in t, where BTM is calculated after accounting for all non goodwill write-offs, but before any goodwill write-off.

Brochet (2010) reports that the informativeness of Form 4 insider-trading filings increases after the SEC mandated timelier filings (since August 2002) and electronic filing (since June 2003).

The academic evidence on the governance characteristics of pooling versus purchase method acquirers and on the consequences of pooling versus purchase method acquisitions is consistent with the SEC’s claim (e.g., Martinez-Jerez 2008).

In untabulated frequency tests, we find none of the discrete explanatory variables used in the multivariate regressions (e.g., Bonus, Delist, InfoAsym, etc.) are significantly associated with each other.

To investigate whether the negative association between Imp and Tenure is driven by firms with new CEOs (assuming new CEOs are more likely to take goodwill write-offs as part of a big bath), we re-run the regressions replacing Tenure with an indicator variable set to one when firm-CEOs have been in office <1 year. The indicator variable is not statistically significant, suggesting that the reported results on Tenure are unlikely to be driven by new-management induced big baths.

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Titel: Evidence on the use of unverifiable estimates in required goodwill impairment
verfasst von: Karthik Ramanna
Ross L. Watts
Publikationsdatum: 01.12.2012
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 4/2012
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-012-9188-5

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