Hirschey - 2002 - Information Contents of Accounting Goodwill Numbers PDF
Hirschey - 2002 - Information Contents of Accounting Goodwill Numbers PDF
Hirschey - 2002 - Information Contents of Accounting Goodwill Numbers PDF
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Information content of
accounting goodwill numbers q
Mark Hirschey *, Vernon J. Richardson
School of Business, University of Kansas, Lawrence, KS 66045-2003, USA
Abstract
Information effects narrowly tied to goodwill write-off announcements are typically
negative and material, on the order of 2–3% of the companyÕs stock price. In the one-
year pre-announcement period, negative information effects on the order of )40% are
also noted. Post-announcement period information effects of roughly )11% suggest that
much, but perhaps not all, of the negative information (valuation) effects tied to
goodwill write-off announcements are realized by the end of the announcement period.
Negative stock-price effects tied to goodwill write-off decisions indicate that accounting
goodwill numbers capture a significant aspect of the intangible dimension of firm value,
and suggest that accounting theory and practice is adept at identifying when such
intangible assets are impaired.
Ó 2002 Elsevier Science Inc. All rights reserved.
1. Prior studies
q
An earlier version of this paper was presented at the meetings of the Financial Management
Association in Seattle, Washington. Several helpful suggestions were made by two anonymous
referees. Of course, only the authors are responsible for what lies herein.
*
Corresponding author. Tel.: +1-785-864-7563; fax: +1-785-864-5328.
E-mail address: [email protected] (M. Hirschey).
0278-4254/02/$ - see front matter Ó 2002 Elsevier Science Inc. All rights reserved.
PII: S 0 2 7 8 - 4 2 5 4 ( 0 2 ) 0 0 0 4 8 - 0
174 M. Hirschey, V.J. Richardson / J. of Accounting and Public Policy 21 (2002) 173–191
Under APB Opinion no. 16, goodwill accounting policy in the US was
starkly different from global standards, and was thought by many to be out of
step with economic reality. For example, Reither (1998) asked a group of
participants in the 1996 American Accounting Association/Financial Ac-
counting Standards Board (AAA/FASB) Financial Reporting Issues Confer-
ence to consider the entire body of accounting standards, and to identify
winners and losers. APB Opinion no. 16 was voted the second worst ac-
counting standard, next to Accounting for Leases, FASB Statement no. 13.
Respondents gave five major reasons for rating APB Opinion no. 16 as among
the worst of all accounting standards. Concerns include: (a) the choice of a
pooling-of-interests or purchase method treatment for a business combination
is arbitrary; (b) under the standard, the form of a business combination can
become more important than its substance; (c) similar business combinations
are accounted for differently; (d) the standard raises the cost of business
combinations as companies strive to meet pooling-of-interest requirements
while avoiding SEC enforcement actions; and (e) the US standard is incon-
sistent with global accounting standards. In most countries, pooling-of-inter-
ests methods are exceedingly rare.
While practical problems involved with identifying and measuring goodwill
make setting a clear and appropriate accounting standard difficult, users of
financial statement information complained that it was difficult to compare
financial results for entities that used different methods of merger accounting.
Users of financial statements also indicated a need for more specific informa-
tion about the value of intangible assets because intangibles have become a
significant proportion of the value motivating many business combinations.
Corporate management also voiced concern that differences between the
pooling and purchase methods of accounting affected competition in the
mergers and acquisitions markets.
After a prolonged period of study and comment, the accounting profession
recently adopted historic new goodwill accounting standards. For fiscal years
that end subsequent to December 15, 2001, Financial Accounting Standards
Board (FASB, 2001a,b) Statement no. 141, Business Combinations (Issued
June, 2001), supersedes APB Opinion no. 16. FASB Statement no. 141 requires
that all business combinations be accounted for by the purchase method. 1 In
addition, FASB Statement no. 141 requires disclosure of the primary reasons
1
FASB Statement no. 141 applies to all business combinations initiated after June 30, 2001, and
all business combinations accounted for using the purchase method for which the date of
acquisition is July 1, 2001, or later. This statement does not apply, however, to combinations of two
or more not-for-profit organizations, the acquisition of a for-profit business entity by a not-
for-profit organization, and combinations of two or more mutual enterprises.
M. Hirschey, V.J. Richardson / J. of Accounting and Public Policy 21 (2002) 173–191 177
for a business combination and an allocation of the purchase price among the
assets acquired. When the amounts of goodwill and intangible assets acquired
are significant, disclosure must be made of the amount allocated among
goodwill and each major intangible asset class. The related FASB Statement
no. 142, Goodwill and Other Intangible Assets (Issued June, 2001), specifically
governs financial reporting for acquired goodwill and other acquired intangible
assets, and supersedes American Institute of Certified Public Accountants,
APB Opinion no. 17, Intangible Assets (Issued 1970). Under the obsolete APB
Opinion no. 17, goodwill and other intangible items were wasting assets with a
finite life. The values assigned to goodwill and other intangible assets were
amortized over an arbitrary period of time not to exceed 40 years. FASB
Statement no. 142 does away with the presumption that acquired goodwill and
other acquired intangible assets have finite lives and eliminates mandatory
amortization. 2 Acquired intangible assets that have finite lives will continue to
be amortized over their useful lives, but without the constraint of any arbitrary
ceiling.
In particular, FASB Statement no. 142 mandates: (a) annual tests
for goodwill and intangible asset impairment. Goodwill will be tested for im-
pairment at least annually using a two-step process that begins with an esti-
mation of the fair value of a reporting unit. The first step is a screen for
potential impairment, and the second step measures the amount of impair-
ment, if any; (b) write-offs of goodwill and intangible asset impairment losses.
If the carrying amount of acquired goodwill or acquired intangible assets ex-
ceeds fair value estimates, an impairment loss must be recognized against net
income in an amount equal to that excess. After goodwill or intangible asset
impairment losses are recognized, subsequent reversals of impairment losses
are prohibited; (c) improved disclosure about goodwill and intangible asset
values and expenses. Information about changes in the carrying amount of
goodwill and other intangible asset categories must be disclosed on an annual
basis, along with estimates of intangible asset amortization expense for the next
five years.
Under FASB Statement no. 142, tests for goodwill and intangible asset
impairment and the write-off of impaired assets promise to become routine
corporate events. This makes it timely to consider whether goodwill write-off
decisions represent ‘‘mere’’ accounting transactions or, instead, signify eco-
nomic events with important implications for the ongoing value of the firm.
2
Costs of internally developing, maintaining, or restoring intangible assets (including goodwill)
that are not specifically identifiable, that have indeterminate lives, or that are inherent in a
continuing business and related to an entity as a whole, continue to be recognized as an expense
when incurred.
178 M. Hirschey, V.J. Richardson / J. of Accounting and Public Policy 21 (2002) 173–191
at the same time that other significant positive or negative earnings informa-
tion is released. ‘‘Simple’’ goodwill announcements unaccompanied by other
important corporate announcements are in the minority. In the present study,
N ¼ 53, or 66.3% of the goodwill write-off announcements studied, are ac-
companied by the contemporaneous disclosure of other important operating
information. 3
Information effects on the stock prices of announcing firms are reported for
the ð1; 0Þ event period for all N ¼ 80 firms, and for each subsample. From an
accounting perspective, we expect negative and statistically significant stock-
price effects tied to goodwill write-off decisions as evidence of a loss of future
profit-generating capability.
Table 1 depicts CAPEs for all sample companies making goodwill write-off
announcements during the five-year 1992–1996 period. Estimation results for
the equally weighted market-model approach are contrasted with those from
3
See Appendix A for further information about the sample.
M. Hirschey, V.J. Richardson / J. of Accounting and Public Policy 21 (2002) 173–191 181
Table 1
CAPEs over the ð1; 0Þ event period for firms announcing goodwill write-off decisions, 1992–1996
ðN ¼ 80Þ
Goodwill write-off Market model Mean-adjusted CAPE Market-adjusted
subsample adjusted CAPE CAPE
Panel A: Goodwill write-offs by type of announcement
‘‘SimpleÕ goodwill write-off announcement ðN ¼ 27Þ
CAPE )2.23% )2.48% )2.83%
t-Statistic ()2.31)b ()2.51)c ()2.93)c
Goodwill write-off w/contemporaneous announcement ðN ¼ 53Þ
CAPE )3.30% )3.73% )3.86%
t-Statistic ()4.48)c ()4.90)c ()5.17)c
4
Each of these methods assumes time series independence in the stock-price reaction tied to
goodwill write-off announcements. Following Beatty et al. (1996) we also tested whether later
announcements were as ‘‘important’’ as earlier announcements, and found no statistically
significant difference related to time of announcement (results available on request).
M. Hirschey, V.J. Richardson / J. of Accounting and Public Policy 21 (2002) 173–191 183
from the Industrial and Commercial Machinery industry group (see Appendix
A). It therefore seems worth asking if the information effects described above
are broadly descriptive of all such goodwill write-off announcements, or more
narrowly relevant for certain manufacturing firms.
For N ¼ 43 goodwill write-offs announcements by manufacturing firms
ð20 6 SIC < 40Þ, Table 1 shows material negative information effects tied to
goodwill write-offs using the market-model approach ()3.32%, t ¼ 4:36), the
mean-adjusted approach ()3.43%, t ¼ 4:33), and the market-adjusted ap-
proach ()3.77%, t ¼ 4:87). For N ¼ 10 goodwill write-offs announcements by
firms in the Industrial and Commercial Machinery industry group ðSIC ¼ 35Þ,
large negative information effects tied to goodwill write-offs are evident using
the market-model approach ()6.03%, t ¼ 2:71), the mean-adjusted approach
()6.60%, t ¼ 2:89), and the market-adjusted approach ()6.72%, t ¼ 2:99).
For N ¼ 33 goodwill write-offs announced by manufacturing firms that are not
in SIC ¼ 35, negative and statistically significant information effects are also
noted using the market-model approach ()2.50%, t ¼ 4:05), the mean-
adjusted approach ()2.47%, t ¼ 3:90), and the market-adjusted approach
()2.88%, t ¼ 4:63). And finally, for N ¼ 37 goodwill write-off announce-
ments by nonmanufacturing firms, negative and statistically significant infor-
mation effects are again noted using the market-model approach ()2.52%,
t ¼ 2:70), the mean-adjusted approach ()3.21%, t ¼ 3:42), and the market-
adjusted approach ()3.25%, t ¼ 3:49).
Based on these results, it seems fair to conclude that negative information
effects of goodwill write-off announcements are relevant for firms across a
broad cross-section of the US industry. In the eyes of the stock market,
goodwill write-offs generally suggest the loss of intangible factors with asset-
like characteristics.
Our finding that goodwill write-off decisions lead to 2–3% adverse stock-
price reactions during the announcement period is compatible with Bartov et al.
(1998) finding of )2.14% announcement period returns for their sample
of tangible asset write-down announcements. Tangible asset write-downs
that convey information about lowered asset values appear to represent un-
equivocally bad news. Still, Bartov et al. (1998) contend that the small size of
these negative ramifications are somewhat anomalous because the typical
tangible asset write-off announcement represented some 20% of the value of
announcing firms. This led Bartov et al. (1998) to consider the possibilities that
the market largely anticipates write-off announcements and/or it underreacts to
them.
The relative magnitude of goodwill write-offs considered in this study tend
to be on the same order of magnitude as tangible asset write-offs studied by
M. Hirschey, V.J. Richardson / J. of Accounting and Public Policy 21 (2002) 173–191 185
Table 2
Cumulative average prediction errors (CAPEs) over three windows ð250; 10Þ, ð1; 0Þ and
ðþ10; þ250Þ event period for firms announcing goodwill write-off decisions, 1992–1996 ðN ¼ 80Þ
Goodwill write-off CAPE year 1 CAPE announcement CAPE year þ 1
subsample ð250; 10Þ period ð1; 0Þ ðþ10; þ250Þ
Panel A: Goodwill write-offs by type of announcement
ÔSimpleÕ goodwill write-off announcement ðN ¼ 27Þ
CAPE )47.55% )2.83% )14.55%
t-Statistic ()4.89)c ()2.93)c ()1.50)a
Goodwill write-off w/contemporaneous announcement ðN ¼ 53Þ
CAPE )38.81% )3.86% )8.98%
t-Statistic ()5.62)c ()5.17)c ()1.30)a
Bartov et al. (1998). In this sample, the mean goodwill write-off of $148.2
million represents 16.3% of the market value of announcing firms. As a result,
long-window pre-announcement and post-announcement period stock-price
behavior surrounding goodwill announcements provide an interesting com-
parison with event-period results. Table 2 shows long-window pre- and post-
announcement period results.
In the one-year (day )250 to )10) period that immediately precedes good-
will write-off announcements, the market-adjusted information effect (cumu-
lative average prediction error) is a large and statistically significant )41.77%
ðt ¼ 7:04Þ for the overall sample. Similarly negative and statistically
significant pre-announcement period effects are also noted for simple good-
will write-off announcements ()47.55%, t ¼ 4:89), and for such announce-
ments accompanied by other important information ()38.81%, t ¼ 5:62).
Large negative and statistically significant pre-announcement period effects
are also typical for both manufacturing ()39.71%, t ¼ 4:98) and nonmanu-
facturing firms ()44.02%, t ¼ 4:97). Negative information effects during
the pre-announcement period document that goodwill write-off announce-
ments come after a prolonged period of market under performance. As such,
goodwill write-off announcements may be interpreted as managementÕs official
recognition that a recently severe downturn in the companyÕs stock portends a
permanent rather than transitory decline in the value of firm assets. Negative
pre-announcements effects also suggest that investors partially anticipate
goodwill write-off decisions, and/or such firms experience a series of related
value-reducing events during the pre-announcement period.
Also as shown in Table 2, firms that announce goodwill write-offs experience
large negative information effects during the one-year (day ¼ þ10 to þ250)
post-announcement period. However, while the average negative post-
announcement period effect of )11.02% ðt ¼ 1:86Þ is statistically significant
over the entire sample of N ¼ 80, it is somewhat variable over each respective
subsample. We conclude from this evidence that most, but perhaps not all, of
the negative valuation effects tied to goodwill write-off announcements are
realized by the end of the announcement period.
This paper extends prior research through further consideration of the in-
formation content of accounting goodwill numbers. Limited prior research
suggests that despite the obvious shortcomings of historical (purchase) ac-
counting goodwill numbers, these data are economically meaningful in that
they are systematically reflected in the market value of the firm. These results
are consistent with the notion that stock-market investors regard goodwill
M. Hirschey, V.J. Richardson / J. of Accounting and Public Policy 21 (2002) 173–191 187
Appendix A
Sulcus said its revenue fell about 12% to $43.1 million from $49.3
million.
Finally, goodwill write-off announcements are sometimes accompanied by
operating information that cannot be precisely tied to earnings performance. A
common example of N ¼ 19 companies making goodwill write-off decision
announcements at the same time other important operating information is
released is given by Tredegar Industries, Inc., on August 29, 1994:
Business Brief––Tredegar Industries, Inc.: Plant to be Closed; Charge
and Write-off are Planned––Tredegar Industries, Inc., Richmond,
VA, said it plans to lease a facility in Graham, NC, to produce injec-
tion-molded packaging components, and close a similar facility in
Alsip, IL, which has 128 employees. Tredegar said it will record a
charge of $1.3 million, or 12 cents a share, for the planned plant clos-
ing, and a goodwill write-off of $3.1 million, or 29 cents a share, due
to disappointing performance in certain lines of the molded-prod-
ucts unit. Both charges will be taken in the third quarter.
same time losses are reported, and N ¼ 19 companies making goodwill write-
off decision announcements at the same time other important favorable or
unfavorable operating information is released. The overall sample of N ¼ 80
goodwill write-off announcements broadly distributed across 32 different SIC
code two-digit industry groups (see Table 3).
Table 3
Goodwill write-off sample breakoff by industry (SIC code)
Two-digit SIC code SIC code description Number
20 Food and kindred products 5
22 Textile mill products 4
23 Apparel 3
27 Printing, publishing and allied industries 2
28 Chemicals and allied products 3
30 Rubber and miscellaneous plastic products 2
31 Leather and leather products 1
34 Fabricated metal products 1
35 Industrial and commercial machinery 10
36 Electronic and other electrical equipment 3
37 Transportation equipment 4
38 Measuring, analyzing and controlling instruments 5
42 Motor freight transportation and warehousing 1
48 Communications 1
49 Electric, gas and sanitary services 3
50 Wholesale trade––durable goods 1
52 Building materials, hardware, garden supply and 1
mobile home dealers
54 Food stores 1
57 Home furniture, furnishings, and equipment stores 1
58 Eating and drinking establishments 3
59 Miscellaneous retail 1
60 Depository institutions 4
61 Nondepository credit institutions 1
62 Security and commodity brokers, dealers, exchanges 1
and services
63 Insurance carriers 4
64 Insurance agents, brokers and service 1
65 Real estate 1
73 Business services 6
76 Miscellaneous repair services 1
78 Motion pictures 1
80 Health services 2
87 Engineering, accounting, research, management and 2
related services
Total sample 80
M. Hirschey, V.J. Richardson / J. of Accounting and Public Policy 21 (2002) 173–191 191
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