Credibility of Managers’ Fair Value Assessments: Evidence from Smaller-than-Expected Goodwill Impairments
43 Pages Posted: 6 Apr 2021
Date Written: April 1, 2021
Goodwill impairment rules compel managers to convey their fair value assessments to investors. Several academic studies suggest that managers, on average, take advantage of discretion under these rules to opportunistically avoid or recognize smaller-than-expected goodwill impairments. We re-examine this conclusion and deliver three main findings. First, 44 percent of firms that avoid or record smaller-than-expected goodwill impairments are justified in doing so based on future stock price recovery. Second, the credibility of managers’ optimistic fair value assessments is positively associated with fundamental firm performance and strong external monitoring. Finally, a trading strategy long in firms that record smaller-than-expected impairments earns excess returns, suggesting that investors do not fully appreciate the signal embedded in these accounting decisions. We conclude that positive private information can be conveyed through smaller-than-expected goodwill impairments.
Keywords: Goodwill impairments, Credibility, Positive private information
JEL Classification: C23, D22, G32, M21, M41
Suggested Citation: Suggested Citation