Common Ownership and Goodwill Impairments

• Published date: 01 November 2024
• Author: Chunlai Ye,Lin‐Hui Yu
• Date: 01 November 2024
• DOI: http://doi.org/10.1111/corg.12581

Corporate Governance: An International Review, 2024; 32:1016–1034

https://doi.org/10.1111/corg.12581

Corporate Governanc e: An International Review

ORIGINAL ARTICLE

Common Ownership and Goodwill Impairments

ChunlaiYe1 | Lin- HuiYu2

1Texas A&M Univers ity at Corpus Christi , Corpus Christi, Texa s, USA | 2National Taiw an University, Taipei, Taiwan

Correspondence: Lin - Hui Yu (linhuiyu@ntu.edu.tw)

Received: 24 Februar y 2023 | Revised: 17 Januar y 2024 | Accepted : 19 February 202 4

Funding: Lin- Hui Yu acknowledges f inancial support of the Nationa l Science and Technology Council , Taiwan.

Keywords: common ownersh ip | corporate governance | go odwill impairment s | SEC

ABS TRACT

Research Question/Issue: Are companies monitored by common owners (i.e., institutional investors that block- own [owning

5% or more] several companies in a single industry) more likely than other companies to record goodwill impairments when their

assets are overstate d?

Research Findings/Insi ghts: We find that companies monitored by common owners are more likely than other compan ies

to record goo dwill impairments when their assets are ov erstated. The monitoring effect is stronger for c ommon owners with a

stronger incentive to monitor and with more industry knowledge and stronger for the co- presence of multiple common owners.

Our finding s are in line with t he notion that common owners have an economy of scale in monitoring and internalize the neg-

ative exter nality of delayed recording of go odwill impairment. We also fi nd that common ownership is a ssociated with lower

information asym metry, which in turn increases the timeliness of goo dwill impairment.

Theoretica l/Academic Implications: Our resea rch emphasiz es the monitoring role of common ownership in recording good-

will impairments. We fi nd support for the mechanisms enabling common owners to be better monitors.

Practit ioner/Policy Implicat ions: The preva lence of common o wnership has prompted regulat ory and soc ietal concerns re-

garding under- investment in the oversight of the companies. Our findings documenting the association between common own-

ership and the timely recordi ng of goodwil l impairments are relevant to t he ongoing debate reg arding the potential costs and

benefits of common ownership.

1 | Introduction

As sha res of US companies ar e increasingly owned by institu-

tional investors, the prevalence of common ownership (where

an institutional investor block- owns at least 5% in t wo or more

companies in t he same industry) has increased and attracte d

regulatory interest and societal concer ns. Institutional investors

are alleged to under- invest in the oversi ght of the companies

they own (Bebchuk and H irst2019; SEC2018). Contrar y to this

concern, He, Huang, and Z hao(2019) and Ramalinge gowda,

Utke, and Yu(2021) find that as common owners have more in-

centives to engage in monitoring activities, common ownersh ip

actually has hig her, rather than lower, monitoring efficiency.

In this study, we expand the literature on common own-

ership by examining whether common ownership affects

companies' decisions to record goodwill impairments. Th is

research question is important, a s it not only investigates

the concern that institutional investors may under- invest in

overseeing management but also provides relevant evidence

to the g rowing interest in understanding the gover nance role

of institutional investor s since the f inancial crisis (McNulty

and Nordberg2016 ). We focu s on common ow nership b ecause

common owner s have superior industr y knowledge, which

sets them apart distinctly from genera l ins titutional owner-

ship. Common ow ners gain private access to corporate infor-

mation from multiple por tfolio compan ies. C ressy, Munar i,

© 2024 John Wi ley & Sons Ltd.

1016

and Malipiero(2007), Eisenhardt(1989), and Kang, Luo, and

Na (2018) suggest that multiple inve stments in a single in-

dustry reduc e information asy mmetry between i nstitutions

and their portfolio companies and increase the effe ctive-

ness of monitoring . Specif ically, common owners can obt ain

industry- specif ic information from portfolio companies. Th is

private information enables common owners to better eval-

uate ma nagers' true effort/talent a nd to b etter assess factors

that determine future cash f lows, such as competitive advan-

tages, customers, and suppliers. Th is information advantage

of common owners ma kes it hard for mana gers to distort fi-

nancial reporting (He, Li, and Yeung2 018; Peng, Yin, and

Zhang2023; Rama lingegowda, Utke, and Yu2021).

In addition to thei r superior industry kno wledge, common

owners also h ave strong inc entive to enga ge in monitor-

ing activ ities. For example, Chen, H arford, and Li (2007)

and Aghion, van Reenen, and Zingales (2013) indicate that

blockholders are more willi ng to devote resources and effort

to monitoring and re ap more benefits than other investors.

Furthermore, He, Huan g, and Zhao (2019) indicate that be -

cause m onitoring h as spillov er effects among peer c ompanies,

monitoring of one company increases f irm value not only in

that company but also in co- owned companies. A ccordingly,

common owners have a stronger i ncentive to engage i n mon-

itoring activities. Finally, Edman s, L evit, and Reilly (2019)

develop a theoretical f ramework show ing that c ommon own-

ers govern investee companies throug h “ voice” and “exit.”

Common owners have incentives to monitor and to communi-

cate with the m anagement team (i.e., voice), as selli ng early is

less profitable. Managers also have a strong incentive to exert

effort as managers worry t hat common owners may sell their

shares (i.e., exit) and m anagers would therefore suffer f rom

a lower stock pr ice. Taken together, as common owners can

effectively discipline management and constrain man agers'

discretion in estimating the fair value of goodwill, we expect

tha t com mon ow nersh ip is posit ively asso ciat ed wit h the time-

liness of goodwi ll impairments.

While the above discussion suggests a pos itive association be-

tween common ownersh ip and goodwill impairments, t he po-

tential concern of anti- competition attributed to common owners

may bias a gainst finding this association. To the extent that the

anti- competit ive beh avior of common owners increa ses pr ofit-

abil ity and the esti mated value of fu ture ca sh flo ws of comp anies '

underlying goodwill, the likelihood of goodwil l impairments may

decrease (A zar, Schmalz, and Tecu2 018; He and Huang2 017).

Overall , because of the competing v iews, how common ow ner-

ship affects goodw ill impairment is an empirical question.

We focus on the goodw ill impairment s etting because this set-

ting does not rely on potentially noisy ear nings ma nagement

proxies (e.g., the di scretionary ac cruals model) and is directly

observed by researchers. In addition, super ior industry k nowl-

edge should play an important role in goodw ill impairment

because of the complexity of the proc esses of impairment te sts.

Although managerial discretion is used in other area s of ac-

counting (e.g., inventory and property, plant, a nd equipment),

estimating the fai r value of goodwill involves a higher degre e of

subjectivity and requires industr y- specific knowledge (goodwil l

impairment tests are subjective and allow managers to exercise

their dis cretion in dis closing private information. Estimate s of

future cash f lows requ ire an assessment of several unpredict-

able fa ctors, includin g a compan y's compet itive ad vanta ges, cus -

tomers, and suppliers; Ramanna and Watts2012). Unlike other

assets, the fai r value of goodwill is unverif iable because there is

no active market for goodwill and because it depends on manag-

ers' future actions and managerial effort to implement corporate

strategies. I n essence, accounti ng for goodwill is a spec ial case

of fair value accounting (Glaum, Landsman, and Wyrwa2018)

and represents a unique sett ing in which common owners c an

use their information advantages gained by monitoring multiple

companies in an industry to discipline managers to record good-

will impairments in a timely manner. While the i nformation

advantage of common ownership is i ntuitively important in fair

value accounting, to the b est of our knowledge, no study has ex-

amined the role of common ownership in fair v alue accounting.

Thus, our study fills this gap and extends prior literature exam-

ining the general impact of in stitutional investors on c orporate

behavior (Koh2007; McNulty and Nordberg2016; Wang2014;

Ward, Yin, and Zeng 2018) (fur ther, our analyses directly ex-

amine repor ting decisions and do not rely on the estimation of

discretionary accru als, mitigating potential measurement errors

from different accrual models. Dechow, Ge, and Schrand(2010)

also note that accrual models cannot identify distortions in-

duced by long- term accruals).

Our a nalys is focu ses on the 2004 –2019 t ime peri od, wit h 27,967

observations hav ing positive total as sets and with material

amounts of pre- impair ment goodwill (i.e., greater t han 0.5% of

revenues) (Ayres etal .2019; Eilifsen and Messier2 014) (th is

th res hold i s wide ly us ed in r ese arch and in prac tice . Our thre sh-

old , 0. 5% of r eve nues , fa lls in th e ran ge su gg est ed by Eil ifs en a nd

Mess ier(2 014). W hile He and Huang (2017) a rgue th at commo n

ownersh ip is associate d with higher market share growth , they

do not find evidence to sug gest anti- competitive behav ior using

market returns of customers (see table8 in He and Huang2017).

Koch, Panayide s, and Thomas (2021) poi nt out that He and

Huang's (2017) firm- level analysis may not be suff icient to have

industry- level implications. In a related study, Dennis, Gerardi,

and Schenone(2022) point out t he concern about the ident ifica-

tion of common ownership in Aza r, Schmalz, and Tec u(2018)

and that t he results of anti- competitive behavior are dr iven by

variat ion in market sha res. Final ly, Lewellen and L owry(2021)

also do not f ind evidence to support anti- competition and con-

clude that such a concern is not warranted). This requirement

ensures that a company has the potential to record material

goodwill impair ment. Consistent with prior literature (Park

et al. 2019; Raman, Ye, a nd Yu 2023), we define a company

as monitored by common ownersh ip if the company shares at

least one blockholder (with owner ship of at least 5% of the total

stock) with at least one other company within the same four-

digit SIC industr y in any quar ter of the year. In other words, a

common institutional owner has blockholding s in at least two

or more companies within a n industry. The sign ificance of a

5% thre shold lies in the fact that blockholders are more moti-

vated to participate in monitoring and information- gathering

activities than shareholders with smaller ownership stakes.

Consi stent with ou r predictio n, we find th at the posit ive assoc i-

ation b etween t he extent of overstat ement of a comp any's as sets

and t he decision to record a goodw ill impair ment is st ronger

when a company shares at least one blockholder with at least

one company in the sa me industry. In addition, the mag nitude

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