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

Andrei Filip, Gerald J. Lobo and Luc Paugam
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Andrei Filip: Catholic University of Lille - IESEG School of Management
Gerald J. Lobo: University of Houston - C.T. Bauer College of Business
Luc Paugam: HEC Paris

No 1400, HEC Research Papers Series from HEC Paris

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 (search for similar items in EconPapers)
JEL-codes: G34 M41 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2020-11-16
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Persistent link: https://EconPapers.repec.org/RePEc:ebg:heccah:1400

DOI: 10.2139/ssrn.3704191

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