Causes and Consequences of Goodwill Impairment Losses

Abstract

The paper examines the reaction of market participants to the announcement of a goodwill impairment loss, the nature of the information conveyed by the loss, and whether a cause of goodwill impairment can be traced back to overpayment for targets at the time of prior acquisitions. We use a comprehensive sample of goodwill impairment announcements made under the regulatory regimes of SFAS 121 and SFAS 142 and explore how the information content changes over different reporting regimes. Our evidence suggests that investors as well as financial analysts revise their expectations downward on the announcement of a goodwill impairment loss and the downward revision is related to the magnitude of the loss. We find that the negative impact of the loss is significant under all three reporting regimes, i.e., pre-SFAS-142, transition period and post-SFAS-142, though it is lower in the post period. We further show that the impairment loss serves as a leading indicator of a decline in future profitability due to a slow-down in sales and/or higher operating costs. Our tests also reveal that proxies for overpayment for targets at the time of prior acquisitions can predict the subsequent goodwill impairment. From our analysis of firms with potentially impaired goodwill that do not report impairment, we find no evidence that market participants revise their expectations at the time of revelation of a zero impairment loss, especially in the post-SFAS-142 period. Indirect evidence suggests that some of these firms may have used their managerial discretion to avoid taking an impairment loss, consistent with the argument in Ramanna (2008) and Ramanna and Watts (2010) that the use of unverifiable fair values under SFAS 142 may lead to the opportunistic avoidance of impairment charges.

Keywords: SFAS 142, write-offs, acquisition, overpayment

JEL Classification: M41, M44, G34