Managerial Discretion to Delay the Recognition of Goodwill Impairment: The Role of Enforcement

Journal of Business Finance & Accounting, Forthcoming

HEC Paris Research Paper No. ACC-2020-1400

55 Pages Posted: 16 Nov 2020 Last revised: 24 Nov 2020

See all articles by Andrei Filip

Andrei Filip

ESSEC Business School

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Luc Paugam

HEC Paris, Accounting and Management Control Department

Date Written: October 3, 2020

Abstract

Under IFRS, managers can use two approaches to increase the estimated fair value of goodwill in order to justify not recognizing impairment: (1) make overly optimistic valuation assumptions, and (2) increase future cash flow forecasts by inflating current cash flows. Because enforcement constrains the use of optimistic valuation assumptions, we hypothesize that enforcement influences the relative use of these two choices. We test this hypothesis by comparing a sample of 1,958 firms from 36 countries that are likely to delay recognizing goodwill impairment (suspect firms) to a sample of control firms. First, we find that firms in high enforcement countries use a higher discount rate to test goodwill for impairment than firms in low enforcement countries. We also find a more positive association between discount rate and upward cash flow management for suspect firms than for control firms. This result is consistent with suspect firms substituting optimistic valuation assumptions with inflated current cash flows. Second, we find that, relative to control firms, suspect firms exhibit higher upward cash flow management in high enforcement countries than in low enforcement countries. Third, we show that suspect firms in high enforcement countries are more likely to eventually impair goodwill.

Keywords: Goodwill impairment, enforcement, cash flow management, valuation assumptions

JEL Classification: M41, G34

Suggested Citation

Filip, Andrei and Lobo, Gerald J. and Paugam, Luc, Managerial Discretion to Delay the Recognition of Goodwill Impairment: The Role of Enforcement (October 3, 2020). Journal of Business Finance & Accounting, Forthcoming, HEC Paris Research Paper No. ACC-2020-1400, Available at SSRN: https://ssrn.com/abstract=3704191 or http://dx.doi.org/10.2139/ssrn.3704191

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)

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

Luc Paugam (Contact Author)

HEC Paris, Accounting and Management Control Department ( email )

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

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