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How Ethical are Managers’ Goodwill Impairment Decisions in Spanish-Listed Firms?

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Abstract

This article provides an analysis of the ethical behavior of managers making goodwill impairment decisions following the adoption of the International Financial Reporting Standard (IFRS) 3 on Business Combinations. Replacing the systematic amortization of goodwill with the impairment-only approach has been a highly controversial step. Although the aim of IFRS 3 was to provide users with more value-relevant information regarding the underlying economics of the business, it has been criticized for the potential earnings management inherent in impairment testing. This study is based on a sample of Spanish-listed companies between 2005 and 2011, a period that embraces the economic crisis. After controlling for the underlying economic factors of the firms, the results suggest that managers are exercising discretion in the reporting of goodwill impairment losses, and big bath and smoothing strategies are influencing the decisions, whether or not to impair goodwill and about the magnitude of the impairment. Firm size is an attribute that appears significant in the analysis, suggesting that the cost and complexity of running the impairment test affect managers’ decisions. Additional analyses suggest that the macroeconomic environment influences opportunistic and unethical behaviors.

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Notes

  1. Using principal components analysis of several financial structure indicators, Bijlsma and Zwart (2013) clustered EU countries into groups. Austria, Denmark, Germany, Greece, Italy, Portugal, and Spain are included in the bank-based group, and The Netherlands, United Kingdom, Belgium, France, Finland, and Sweden in the market-based one. Whereas other EU countries do not fit well in any of these groups, this breakdown confirms that the traditional classification that serves as the basis of the so-called continental vs Anglo-American accounting systems is still valid (Nobes 1983).

  2. In this section, we refer to IFRS 3 (IASB 2004a) and IAS 36 (IASB 2004b), which is the accounting regulation that affects EU countries. Despite some differences in the specific impairment rules, the first step, including the estimation of the fair value of the cash-generating unit (CGU) in order to appreciate if an impairment should be recorded, is basically consistent with the related USGAAP—Statement of Financial Accounting Standard (SFAS) 141 (FASB 2001a) and 142 (FASB 2001b).

  3. IFRS 3 requires that acquired assets, liabilities, and contingent liabilities are recognized at fair value by the acquirer if they satisfy the recognition criteria, whether or not they have been recognized previously. Any difference between the purchase price and the total fair value of the identifiable net assets should be recognized as goodwill (IASB 2004a, IFRS 3, para. 36).

  4. EFRAG advises the EU prior to the adoption of IFRS (see Richardson and Eberlein 2011). The IFRS 3 endorsement letter is available at http://ec.europa.eu/internal_market/accounting/committees/efrag_endorsement_advices_en.html.

  5. These authors discuss the adoption of SFAS 141 and SFAS 142 as a case of macro-manipulation and maintain: “In order to be able to introduce the standard eliminating pooling FASB had to make a major concession by removing the requirement to amortize goodwill, thus creating an opportunity for some creative earnings management at the individual company level” (Gowthorpe and Amat 2005, p. 60).

  6. The big-bath strategy consists of a one-time overstatement of charges against income to reduce assets, which reduces future expenses and increases future income accordingly. The expectation is that the loss is discounted in the market by analysts and investors who will focus on future earnings.

  7. This approach provides consistent, asymptotically efficient coefficient estimates despite the correlation of the residuals across the two processes—the decision to have a goodwill impairment and the equation of interest.

  8. In the absence of exclusion restrictions, the results for the inverse Mills ratio depend entirely on its nonlinearity; this aspect is an issue because theory rarely suggests what the correct functional form is. Thus, the coefficients of the variables included in both models would not be properly estimated due to multicollinearity problems when there are no variables excluded in the OLS (Lennox et al. 2012).

  9. Income smoothing is normally seen as an instrument for reducing transparency, but, as Chih et al. (2008) have noted, some scholars take the opposite view, arguing that more valuable information is conveyed to uninformed investors by lowering earnings volatility.

  10. Under the extremely restrictive assumption that firms have only one CGU and that the market value of the outstanding shares captures its recoverable amount, this contingency analysis may imply a high level of noncompliance with the impairment test requirements. A similar conclusion was obtained by the European Securities and Markets Authority (ESMA) after analyzing the accounting practices of 235 issuers: “ESMA found that significant impairment losses of goodwill recognized in 2011 were limited to a handful of issuers, particularly in the financial services and telecommunication industry” (ESMA 2013, p. 3). The report is available at http://www.esma.europa.eu/system/files/2013-02.pdf.

  11. In the second stage, the sample sizes for the two subperiods are small, as there are few observations with impairment—33 and 71, respectively—which does not allow us to run a regression with 10 independent variables. We have performed a Tobit analysis as an alternative solution; it includes 213 and 325 observations in each of the two subperiods, although that does not allow us to separate the two decisions.

  12. Similarly, Reverte (2009) concludes that the factors influencing the corporate social responsibility disclosure practices of Spanish-listed companies are not significantly different from the factors that influence them in other environments.

Abbreviations

CGU:

Cash-generating unit

EU:

European Union

EUR:

Euro

EFRAG:

European Financial Reporting Advisory Group

ESMA:

European Securities and Markets Authority

FASB:

Financial Accounting Standards Board

GAP:

General accounting plan

GDP:

Gross domestic product

IAS:

International Accounting Standards

IASB:

International Accounting Standards Board

IFRS:

International Financial Reporting Standards

IOS:

Investment opportunity set

M&A:

Mergers and acquisitions

OLS:

Ordinary least squares

SFAS:

Statement of Financial Accounting Standards

UK:

United Kingdom

US:

United States

USA:

United States of America

USD:

United States Dollar

USGAAP:

United States generally accepted accounting principles

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Acknowledgments

We are grateful to the editor and two anonymous reviewers as well as to Juan Sanchis for their very constructive comments. We also appreciate comments on earlier versions of this paper from participants at the EAA Conference in Paris, as well as from workshop participants at the Audit and Accounting Convergence Conference in Cluj and the University College Dublin. The authors gratefully acknowledge the financial contribution of the Spanish Ministry of Economy and Competitiveness (research project ECO2013-48208-P).

Author information

Authors and Affiliations

  1. Department of Accounting, University of Valencia (Spain), Avenida dels Tarongers s/n, 46071, Valencia, Spain

    Begoña Giner & Francisca Pardo

Authors
  1. Begoña Giner
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  2. Francisca Pardo
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Corresponding author

Correspondence to Begoña Giner.

Appendices

Appendix 1: Institutional Characteristics

 

Spain

United Kingdom

European Union (*)

Bank—intermediate credit

0.82

0.33

0.45

Equity funding—stock market capitalization

0.88

1.16

0.67

Equity funding—issuance of shares

0.01

0.02

0.01

Anti-directors’ rights

4.00

5.00

2.60

Rule of law (1)

7.80

8.57

9.04

Rule of law (2)

1.14

1.68

1.50

Regulatory quality

1.18

1.72

1.42

Control of corruption

1.08

1.69

1.56

  1. * The average values have been obtained from the available European countries for each indicator at the related time period
  2. Bank—intermediate credit: bank credit to the non-financial companies as a percentage of GDP, which indicates the role of the banking system in channeling funds to non-financial corporations. Average of the period 2005–2011. Source Bijlsma and Zwart (2013)
  3. Equity funding—stock market capitalization: stock market capitalization of listed firms as a percentage of GDP, which indicates the role of the market in channeling funds to non-financial corporations. Average of the period 2005–2011. Source Bijlsma and Zwart (2013)
  4. Equity funding—issuance of shares: gross issuance of shares by listed firms as a percentage of GDP, which indicates the stock market activity. Average of the period 2005–2011. Source Bijlsma and Zwart (2013)
  5. Anti-directors’ rights: an index aggregating shareholder rights from company and commercial law which proxies for investor’s protection. It ranges from 0 to 6, with lower scores for countries with less investor protection. Source La Porta et al. (1998). Available at http://faculty.tuck.dartmouth.edu/rafael-laporta/research-publications
  6. Rule of law (1): assessment of the law and order tradition in the country, which proxies for enforcement. Scale from 0 to 10, with lower scores for less tradition for law and order. Average of the period 1982 and 1995. Source La Porta et al. (1998). Available at http://faculty.tuck.dartmouth.edu/rafael-laporta/research-publications
  7. Rule of law (2): assessment of the perceptions in which agents have confidence and abide by the rules of society—particularly the quality of contract enforcement, property rights, the police, and the courts. It ranges between −2.5 and 2.5, with higher scores corresponding to better outcomes. Average of the period 2005–2011. Source Kaufmann et al. (2013). Available at www.govindicators.org
  8. Regulatory quality: assessment of perceptions of the ability of government to formulate and implement sound policies and regulations that permit and promote private-sector development. It ranges between −2.5 and 2.5, with higher scores corresponding to better outcomes. Average of the period 2005–2011. Source Kaufmann et al. (2013). Available at www.govindicators.org
  9. Control of corruption: assessment of the perceptions to which public power is exercised for private gain. It ranges between −2.5 and 2.5, with higher scores corresponding to better outcomes. Average of the period 2005–2011. Source Kaufmann et al. (2013). Available at www.govindicators.org

Appendix 2. Announced Mergers & Acquisitions in Spain

See Fig. 1.

Fig. 1
figure 1

Analysis of Thomson Financial, Institute of Mergers, Acquisitions and Alliances (IMAA). Available at http://www.imaa-institute.org/statistics-mergers-acquisitions.html

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Giner, B., Pardo, F. How Ethical are Managers’ Goodwill Impairment Decisions in Spanish-Listed Firms?. J Bus Ethics 132, 21–40 (2015). https://doi.org/10.1007/s10551-014-2303-8

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