The Value Relevance of Goodwill Impairments on European Stock Markets -An Event Study of European Stock Markets' Short-Term Behavior to Released Information Regarding Goodwill Impairments

Abstract

Background and Discussion: In 2002 the EU decided to force all European listed companies to adopt the standards issued by the IASB for their consolidated financial statements. As a result of the IFRS implementation, amortization of goodwill is no longer permitted. Instead, goodwill must be tested for yearly impairment. The purpose with impairment testing is to successively impair the goodwill amount when realizing its synergy effects. However, there is much criticism against the possibility for professionals to interpret the IFRS framework to their own advantage. Investors previously saw goodwill amortizations as an irrelevant consequence of past investments, but many previous studies claim that nowadays, investors incorporate goodwill impairments in their firm valuation assessments. Purpose and Research Question: The purpose is to provide a broader picture of the markets’ reaction to goodwill impairments. The research question is: do investors find goodwill impairments value relevant? If yes, does the size of the impairment generate different market reactions? Methodology: To be able to test whether the share prices react to the announcement of goodwill impairments, the thesis uses an event study approach. In short, the study detects reactions in share prices when the market receives information from the year-end reports containing goodwill impairments. Since much more information in addition to the potential goodwill impairments is released, the study also, with a regression analysis, takes earnings, growth, liquidity and capitalization measures into account, as well as macroeconomic impact. Results and Conclusions: The study provides evidence that there is a statistically significant reaction in share price returns surrounding the announcement of a goodwill impairment, although at α=0.10 level. More specifically, the mean of CAR (-0.16%) is significantly lower than zero. The result also demonstrates that goodwill impairment ratio is the best explanatory variable for changes in CAR, provided through a regression analysis. The regression coefficient of -0.0136639 indicates that if a firms’ impairment rate increases by 1 unit, all else being equal, CAR decreases by 0.0136639. One could argue that the economic effect is very low, but there still is a significant correlation (at α=0.05 level) between the variables. The study also verifies that the size of the goodwill impairment in relation to total goodwill generates different market reactions: the group with a low goodwill impairment ratio had a negative coefficient of -0.324, while in comparison the group with a higher goodwill impairment ratio had a negative coefficient of -0.017. The study concludes that markets do react to information about goodwill impairments and therefore investors do find goodwill impairments value relevant. Further, smaller impairments tend to generate more negative short-term reactions.