The Market Disciplinary Effect of Asset Write-Off: Theory and Empirical Evidence from Goodwill Impairment

ABSTRACT

We study the effect of subsequent write-off tests on myopic managers’ investment decisions. Write-off tests discipline overinvestment when the likelihood of adverse events is high but can otherwise cause more severe underinvestment. Hence, tightening impairment stringency improves firm value when the likelihood of adverse events is high but destroys firm value when that likelihood is low. With intermediate levels of likelihood, firm value is hump-shaped in impairment stringency. To test the theory, we exploit an increase in goodwill impairment stringency following goodwill-related restatements by peer firms audited by the same auditor office, and we adopt a stacked difference-in-differences (DiD) design to control for any generic effects of peer restatements. Firms facing more stringent goodwill impairment reduce M&As relative to other types of investment, as well as in absolute amounts. The valuation of treated firms improves only during periods of high recession expectations or when facing high distress risk.

Data Availability: Data are available from sources identified in the text.

JEL Classifications: D82; G31; G34; M41; M42.