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"Goodwill"
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Has goodwill accounting gone bad?
Prior to SFAS 142, goodwill was subject to periodic amortization and a recoverability-based impairment test. SFAS 142 eliminates periodic amortization and imposes a fair-value-based impairment test. We examine the impact of this standard on the accounting for and valuation of goodwill. Our results indicate that the new standard has resulted in relatively inflated goodwill balances and untimely impairments. We also find that investors do not appear to fully anticipate the untimely nature of post-SFAS 142 goodwill impairments. Overall, our results suggest that, in practice, some managers have exploited the discretion afforded by SFAS 142 to delay goodwill impairments, thus temporarily inflating earnings and stock prices.
Journal Article
Evidence on the use of unverifiable estimates in required goodwill impairment
SFAS 142 requires managers to estimate the current fair value of goodwill to determine goodwill write-offs. In promulgating the standard, the FASB predicted that managers will, on average, use the fair-value estimates to convey private information on future cash flows. The current fair value of goodwill is unverifiable because it depends in part on management’s future actions (including managers’ conceptualization and implementation of firm strategy). Agency theory predicts managers will, on average, use the unverifiable discretion in SFAS 142 consistent with private incentives. We test these hypotheses in a sample of firms with market indications of goodwill impairment. Our evidence, while consistent with some agency-theory based predictions, does not confirm the private information hypothesis.
Journal Article
Do financial analysts compel firms to make accounting decisions? Evidence from goodwill impairments
This paper examines whether financial analysts’ presence compels recognition of goodwill impairments. Analysts could impact managers’ impairment decisions in at least two ways: (1) by improving the information environment through their analysis of firm performance (i.e., ex ante monitoring) and (2) by increasing the likelihood the manager and firm experience negative consequences when they fail to record a necessary impairment (i.e., ex post monitoring). We find that the likelihood of an impairment is more strongly related to an expected impairment when analyst coverage is higher. Consistent with both forms of monitoring, we also find that analyst downgrades before the firm’s reporting date increase the probability that management records an expected impairment at the reporting date and that failing to record an expected impairment is associated with decreases in analyst following and a lower likelihood that managers are employed at the end of the following year.
Journal Article
Carbon Tail Risk
Strong regulatory actions are needed to combat climate change, but climate policy uncertainty makes it difficult for investors to quantify the impact of future climate regulation. We show that such uncertainty is priced in the option market. The cost of option protection against downside tail risks is larger for firms with more carbon-intense business models. For carbon-intense firms, the cost of protection against downside tail risk is magnified at times when the public’s attention to climate change spikes, and it decreased after the election of climate change skeptic President Trump.
Journal Article
How Valuable Is Financial Flexibility when Revenue Stops? Evidence from the COVID-19 Crisis
Firms with greater financial flexibility should be better able to fund a revenue shortfall resulting from the COVID-19 shock and benefit less from policy responses. We find that firms with high financial flexibility within an industry experience a stock price drop that is 26%, or 9.7 percentage points, lower than those with low financial flexibility. This differential return persists as stock prices rebound. Firms more exposed to the COVID-19 shock benefit more from cash holdings. No evidence suggests that recent payouts worsened the average firm’s drop in stock price. Our results cannot be explained by a leverage effect.
Journal Article
FIRM-LEVEL POLITICAL RISK
We adapt simple tools from computational linguistics to construct a new measure of political risk faced by individual U.S. firms: the share of their quarterly earnings conference calls that they devote to political risks. We validate our measure by showing that it correctly identifies calls containing extensive conversations on risks that are political in nature, that it varies intuitively over time and across sectors, and that it correlates with the firm’s actions and stock market volatility in a manner that is highly indicative of political risk. Firms exposed to political risk retrench hiring and investment and actively lobby and donate to politicians. These results continue to hold after controlling for news about the mean (as opposed to the variance) of political shocks. Interestingly, the vast majority of the variation in our measure is at the firm level rather than at the aggregate or sector level, in the sense that it is captured neither by the interaction of sector and time fixed effects nor by heterogeneous exposure of individual firms to aggregate political risk. The dispersion of this firm-level political risk increases significantly at times with high aggregate political risk. Decomposing our measure of political risk by topic, we find that firms that devote more time to discussing risks associated with a given political topic tend to increase lobbying on that topic, but not on other topics, in the following quarter.
Journal Article