When do smaller-than-expected goodwill impairments reflect managers’ positive private information?

Abstract

We examine firms that do not significantly impair goodwill despite a strong market signal (i.e., market-to-book ratio below one) that large impairments are expected. Based on subsequent stock returns sufficient to lift market values above book values, we find that nearly half of these firms appear justified in their smaller-than-expected goodwill impairments. Investors react positively to the lack of impairments, particularly when firm characteristics suggest the decision is based on positive private information. Characteristics indicative of the positive private information explanation include (a) strong operating performance, (b) external monitoring, and (c) managers that have an informational advantage over investors. Comparing firms with and without goodwill balances, we also find that goodwill impairment rules force firms with goodwill balances to have more defensible reasons to retain their high book values when facing low equity market values. Overall, the evidence suggests managers’ goodwill impairment decisions serve as a channel to convey positive private information.

Keywords: Goodwill impairment, Private information, Accounting discretion, Fair value accounting

JEL Classification: C23, D22, G32, M21, M41