Using Real Activities to Avoid Goodwill Impairment Losses: Evidence and Effect on Future Performance

Forthcoming in Journal of Business Finance and Accounting

57 Pages Posted: 19 Nov 2014 Last revised: 5 Dec 2014

See all articles by Andrei Filip

Andrei Filip

ESSEC Business School

Thomas Jeanjean

ESSEC Business School - Department of Accounting and Management Control

Luc Paugam

HEC Paris, Accounting and Management Control Department

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Date Written: November 8, 2014

Abstract

We examine whether managers postpone the recognition of goodwill impairment by manipulating cash flows and the consequences of such a strategy on future performance. According to SFAS 142, an impairment loss must be recognized if the reporting unit’s total fair value to which goodwill has been allocated is less than its book value. A growing body of empirical evidence shows that managers delay the recognition of goodwill impairment in accounting books. However, past literature is silent on how managers convince various gatekeepers (e.g., auditors, financial analysts) that recognizing an impairment loss is unnecessary although it seems economically justified. SFAS142 requires managers to forecast future cash flows to justify the decision to recognize or not an impairment loss. Therefore we predict that managers manipulate upward current cash flows to support their choice to avoid reporting an impairment loss. We also test whether or not this real earnings management is detrimental to future performance. Based on a sample of US firms over the 2003-2011 period, we document that firms suspect of postponing goodwill impairment losses exhibit significantly positive discretionary cash flows compared to various control groups. We also find that this real activities manipulation is detrimental to future performance.

Keywords: goodwill impairment, earnings management, cash flow management, real activities

JEL Classification: M40, M41, G10, G14

Suggested Citation

Filip, Andrei and Jeanjean, Thomas and Paugam, Luc, Using Real Activities to Avoid Goodwill Impairment Losses: Evidence and Effect on Future Performance (November 8, 2014). Forthcoming in Journal of Business Finance and Accounting, Available at SSRN: https://ssrn.com/abstract=2521341 or http://dx.doi.org/10.2139/ssrn.2521341

Andrei Filip

ESSEC Business School ( email )

3 Avenue Bernard Hirsch
CS 50105 CERGY
CERGY, CERGY PONTOISE CEDEX 95021
France
+33 1 34 43 33 61 (Phone)

Thomas Jeanjean (Contact Author)

ESSEC Business School - Department of Accounting and Management Control ( email )

Av Bernard Hirsch
Cergy-Pontoise 95021
France

Luc Paugam

HEC Paris, Accounting and Management Control Department ( email )

1 avenue de la libération
Jouy-en-Josas, 78350
France

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