Goodwill valuations certified by independent experts: Bigger and cleaner impairments?

• Published date: 01 January 2020
• DOI: http://doi.org/10.1111/jbfa.12411
• Author: Ye Wang,Miles Gietzmann
• Date: 01 January 2020

DOI: 10.1111/jbfa.12411

Goodwill valuations certified by independent

experts: Bigger and cleaner impairments?

Miles Gietzmann1Ye Wang 2

1Department of Accounting, Bocconi University,

Milan, Italy

2School of Banking and Finance, University of

International Business and Economics, Beijing,

China

Correspondence

MilesGietzmann, Department of Accounting,

Universityof Bocconi, Via Sarfatti 25 Milano,

20135Italy.

Email:miles.gietzmann@unibocconi.it

Abstract

If firms disclose the use of independent valuation experts to assess

the magnitude of goodwill impairments, should investors rationally

condition their values on that disclosure? This research shows that

firms that disclose the use of an independent valuation expert are

more likely to report a higher impairment charge in an impairment

year but, critically, after controlling for other determinants, the

disclosing firms are less likely to have impairments in following

years. Thus, when the use of an independent expert is disclosed,

while it is rational for investors to downgrade firm value on the

basis of the disclosed (higher) impairment charge in that year, there

is simultaneously a reduced need to add an additional discount

to anticipate further (strategically) delayed impairment charges.

The investors need to consider the likely multi-period time series

properties of impairments, and firms may benefit from using an

expert if in anticipation of future related impairments, investors

significantly reduce the discount applied.

KEYWORDS

certification, goodwill, impairment testing, intangible assets, SFAS

142, valuation experts

JEL CLASSIFICATION

G32, M41

1INTRODUCTION

A major new component of SFAS142 (Goodwill and Other Intangible Assets, Issued 6/01) was a provision that allowed

the replacement of an annual amortization charge for goodwill with an (at least) annual impairment test in which the

fair value of goodwill was critically reassessed. The FASB claimed that the new standard would ‘improve financial

reporting because the financial statements of entities that acquire goodwill and other intangible assets will better

reflectthe underlying economics of those assets. However, given the inherent difficulty in valuing intangibles, at issue is

whether an unintended consequence of SFAS142 was that instead it introduced ‘more aggressive accounting, whereby

assets are initially capitalized at cost then only written down in the face of overwhelming evidence of impairment’

(Li & Sloan, 2017, p. 2). This potential feature of SFAS142 leads Li and Sloan (2017) to conclude that despite the claims

J Bus Fin Acc. 2020;47:27–51. wileyonlinelibrary.com/journal/jbfa c

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28 GIETZMANN ANDWA NG

by the SEC that the new standard would result in goodwill valuations better reflecting the underlying economics of

those assets, ‘it is possible that the practical application of SFAS142 may actually have worsen(ed) financial reporting’

(p. 1).

In their empirical analysis, Li and Sloan (2017) find evidence that SFAS142 is associated with inflated goodwill bal-

ances and untimely impairments. In contrast,other research, such as Jarva (2009), fails to find convincing evidence that

firmsopportunistically avoid impairments. Given the lack of consensus, one possibility for firms (attempting to enhance

the perceived reliability of their goodwill accounting) is to use independent experts to advise them and to certify that

the firms are indeed not reporting in an opportunistic way. Our research tests whether the time series properties of

goodwill impairments made by firms using independent expertsdiffers from the properties of goodwill impairments of

firms that do not disclose the use of experts.

Although our primary concern is whether firms act opportunistically (Jarva, 2009; Li & Sloan, 2017), it is also rel-

evant to consider prior research on changing patterns of conservatism. Kim, Lee, and Yoon (2013) and André, Filip,

and Paugam (2015) investigate how regulatory changes in goodwill accounting in the US and Europe affect the asym-

metric timeliness of earnings (accounting conservatism). The impairment testing at the heart of goodwill accounting is

an example of where increased conditional conservatism would be expected to be applied to address additional con-

tracting difficulties arising from the new standards. Our research differs from that approach in that we do not consider

conservatism as the only instrument firms have to signal their intentions. Instead, we consider a new,previously unre-

searched instrument—the employment of an independent valuation expert.

Tounderstand why independent certification may be a helpful additional instrument, the problem of hidden good-

will impairments can be cast within a classic adverse selection (hidden information) setting. One of the general insights

from the theory of adverseselection is that economic agents may attempt to overcome problems of hidden information

by using commitment devices such as independent certification (Dranove& Jin, 2010; Viscusi, 1978).

While one could argue that it is the role of the externalauditor to provide certification in relation to goodwill impair-

ment, there is evidence1to suggest that external auditors are not well suited to certify the fair value of an intangible

asset since their expertise lies in the transactional recording of historic costs. As a consequence, this may explainwhy

somefirms are turning to independent valuation experts to certify the reported fair values for goodwill and other intan-

gible values.

Our study is the first to investigate the use of independent valuation experts by firms to improve the quality of

goodwill reporting. In our primary hypotheses,we define quality with respect to both the timeliness and the magnitude

of impairment charges. We then compare and contrast the goodwill impairments’ timeliness and magnitudes (levels)

conditional on the use of independent experts. We find that firms that disclose the use of an independent valuation

expertnot only have bigger initial year disclosures but critically also have disclosures that are cleaner,as the disclosures

are less likely to be followed byadditional follow-on impairments.

The paper is organized as follows. In section 2, we discuss the background research for our study and how it under-

pins our hypotheses. In section 3, we detail the research design. In section 4, we present the sample selection, descrip-

tive statistics and our main empirical results, and we give our conclusion in section 5.

2BACKGROUND AND HYPOTHESES

Our research is the first to formally consider the impact of using an independent expert to provide advice on goodwill

impairment. Givenour focus on the role of experts,two other related sources are relevant: the economics-based litera-

ture on the incentives of expertsand also the literature on the demand for independent certification. Given the volume

of that wider relevant literature, we refer the reader to Boennen and Glaum (2014) for a more comprehensive review

of the goodwill accounting literature.

1Seethe subsequent discussion of the findings of the PCAOB.