Evidence from Goodwill Non-Impairments on the Effects of Using Unverifiable Estimates in Financial Reporting

Abstract:     
SFAS 142 requires managers to estimate reporting unit values to determine goodwill write-offs. Those estimates often use unverifiable discounted-future-cash-flows providing managers with more discretion than historically afforded in financial reporting. Ex post, managers can claim their unit value estimates were not realized due to factors outside their control, claims that are difficult to objectively falsify. In promulgating SFAS 142, standard setters assume managers, on average, use unverifiable discretion to convey private information on future cash flows; in contrast, agency theory predicts managers, on average, use unverifiable discretion opportunistically. We test these alternative hypotheses using a sample of firms with market indications of goodwill impairment. Our evidence, while consistent with agency theory, does not confirm the private information hypothesis.

Keywords: agency theory, goodwill impairment, fair-value accounting, FASB, SFAS 142

JEL Classifications: M41, M43, M44, M46, D82, G38, K22

Working Paper Series