Cash flow prediction ability of goodwill impairments and related controls

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School of Business | Master's thesis
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Degree programme
86 + 16
This research studies the information value of goodwill by examining the association between reported goodwill impairments and next period cash flows. Because current SFAS 142 standard requires managers to conduct goodwill impairments based on their own fair value estimates, the reported goodwill impairments can be assumed to reveal some inside information that is useful for cash flow prediction. On the other hand, multiple researchers (e.g. Ramanna and Watts, 2012) have found evidence that managers are using discretion allowed in goodwill standards for opportunistic motives, which decreases the information value of reported goodwill impairments. The used sample extends from 2001 to 2015 and contains US companies obtained from Compustat. The research uses a traditional cash flow prediction model by Barth et al. (2001), by extending it to include a separate individual variable for goodwill impairments similarly as Jarva (2009) and Bostwick et al. (2016). This research focuses to provide more evidence of how strong association between future cash flows and goodwill impairments the used model is able to detect, and to use the model to test how control variables are associated with the information value of goodwill. The results show that the inclusion of a separate variable for goodwill impairments significantly improves the cash flow prediction ability of the model. The improvement is however only marginal and considerably smaller compared to results in Bostwick et al., which results are found to be improved due the use of outlier restrictions. A weak evidence is found to support that the tested controls are associated with the cash flow prediction ability of goodwill impairments. The control tests are however affected by the weak association between next period cash flows and goodwill impairments, and none of the tested control variables is found to have strongly significant effect on the results. Furthermore, inconsistencies in the reported coefficients for goodwill impairments variable in previous studies are found to be related to the definition of one regression variable in Bostwick et al. research, and it can be corrected by changing a sign of one term in a formula defining that regression variable.
Thesis advisor
Niemi, Lasse
goodwill impairments, cash flow prediction, SFAS 142, fair value accounting
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