Do controlling shareholders share pledging affect goodwill impairment? Evidence from China

• DOI: https://doi.org/10.1108/IJAIM-07-2021-0141
• Published date: 27 October 2021
• Date: 27 October 2021
• Pages: 793-822
• Author: Yanxi Li,Shanshan Ouyang

Do controlling shareholders share

pledging affect goodwill

impairment? Evidence from China

Yanxi Li and Shanshan Ouyang

School of Economics and Management, Dalian University of Technology,

Dalian, China

Abstract

Purpose –The purposeof this study is to examine the impact of controlling shareholders’sharepledging on

goodwillimpairment.

Design/methodology/approach –This study empirically investigates the effect of controlling

shareholders’sharepledging on both the decision and amountof goodwill impairment for Chinese listed firms

from 2007 to 2017.

Findings –This study finds that the proportion of controllingshareholders’share pledging is negatively

related to both impairment decisions and amounts; these negative relationships are intensified when firms

face high stock price crash risks. In addition,the empirical results show that firms with larger share pledging

are less likely to recognizegoodwill impairment or are likely to record relatively smallerimpairment amounts

when they are followedby fewer financial analysts.

Originality/value –Most of the relevant literature has focused on managers’behaviors toward goodwill

impairments, whileless attention has been given to goodwill impairments from the perspective of controlling

shareholders.In fact, controlling shareholders may have strong incentivesto protect their control rights when

they exercise disproportionate control rights, especially in China. Given the high ownership concentration,

prior studies may not have adequately explainedthe agency problem of controlling shareholders in goodwill

impairment.This study uses share pledging as a case to fill this gap. Specifically, it investigates whetherboth

goodwillimpairment decisions and amounts are affected by controlling shareholders’sharepledging.

Keywords Goodwill impairment, Stock price crash risk, Analyst coverage, Controlling shareholder,

Share pledging

Paper type Research paper

1. Introduction

In 2004, the International Accounting Standards Board (IASB) issued International

Financial Reporting Standards3 (IFRS3), Business Combinations. IFRS3 abolished periodic

goodwill amortization and required that all goodwill be tested annually or more frequently

for impairments using estimates of its current fair value. Compared with the amortization

approach, impairment-only approach has attracted more attention from investors. Li et al.

(2011) show that announcements of goodwill impairment loss would influence investors to

revise their expectationsof future cash flows downward, therebycausing a negative market

reaction. Moreover, prior studies have agreed on the existence of managerial discretion in

Funding: This work was supported by the Key Program of National Social Science Foundation of

China under Grant [No. 18ZDA095].

Author contributions: SO and YL conceived and designed the research. SO collected and analysed

the data. SO wrote the paper in consultation with YL. All authors discussed the results and

contributed to the final manuscript.

Controlling

shareholders

share pledging

793

Received12 July 2021

Revised30 August 2021

Accepted6 September 2021

InternationalJournal of

Accounting& Information

Management

Vol.29 No. 5, 2021

pp. 793-822

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-07-2021-0141

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

the impairment test for goodwilland have argued that managers might use this discretion to

avoid goodwill impairment recognition for a positive stock price reaction. For example,

managers are more likely to delay impairment when they have debt covenants, earnings-

based bonuses or in-the-money exercisable stock options (Abughazaleh et al.,2011;

Lapointe-Antuneset al.,2008;Ramannaand Watts, 2012).

However, most of the relevant literature has focused on managers’behaviors toward

goodwill impairments,while less attention has been given to goodwill impairmentsfrom the

perspective of controlling shareholders. In fact, controlling shareholders may have strong

incentives to protect their controlrights when they exercise disproportionate control rights,

especially in China (Gul et al.,2010;Liu and Lu, 2007). China’s capital markets are

characterized by a high concentration of ownership (Hou et al., 2012). Despite the market

reform in 2005 [1], ownership interests commonly remained highly concentrated in the

hands of a few large shareholders (Huang, 2016). With highly concentrated ownership,

controlling shareholders typically play a dominant role on the board and at shareholder

meetings, and can influence executive selections (Hou et al.,2015;Yeh and Woidtke, 2005).

Through direct or indirect involvement, controlling shareholders arecapable of influencing

the firm’s affairs, including financial reporting choices. For example, controlling

shareholders in China may intervene and encourage earnings management for private

interests (Dong et al.,2020), and influence firmsto adopt accounting policies that reflect their

own wishes (Firth et al., 2007). Thus, given the high ownership concentration, prior studies

may not have adequately explained the agency problem of controlling shareholders in the

impairment test for goodwill.This study uses share pledging as a prominent case to fill this

gap. Specifically, it investigates whether both goodwill impairment decisions and amounts

are affected by controllingshareholders’share pledging.

Share pledging is a scenarioin which shareholders (borrowers or pledgers) use their own

shares as collateral to obtain loans from financial institutions (lenders or pledgees).

Compared with other types of loans, share pledging is favored by controlling shareholders

because of its relatively low cost, fast financing and simple approval process (Chan et al.,

2018). Although share pledgingis convenient for shareholders, some associated risks cannot

be ignored. When the share price falls belowa certain level requiredby pledging contracts,a

margin call is triggered. In a margin call, if pledgers cannot deposit more funds or repay

loans, pledgees can dump their pledgedshares. If the pledgers are controlling shareholders,

they would lose their ownership and control of firms (Ouyang et al.,2019). Thus, controlling

shareholders may be incentivizedto use all their power to relieve margin call pressure when

they have share pledged (Chan et al., 2018;Ouyang et al.,2019;Xu et al.,2020). Given the

complexity of goodwillaccounting and discretion in the impairment test (Andreicoviciet al.,

2019), we predict that controllingshareholders involved in share pledging may understateor

simply not recognize goodwillimpairment losses to maintain share prices. With the increase

in the stock price crash risk, the manipulation of goodwill impairment would be stronger

because of the higher probabilityof the share price falling below the warning line. However,

financial analyst coverage,as a type of external corporate governance, will deterfirms (Chen

et al.,2016;Chen et al.,2015), and we predict that the adverse impact of share pledging on

both impairment decisions and amountswill be alleviated when firms are followed by more

financial analysts.

This study empiricallyinvestigates the effect of controlling shareholders’sharepledging

on both the decision and amount of goodwill impairment forChinese listed firms from 2007

to 2017. We find that the proportionof controllingshareholders’share pledging is negatively

related to both the decisions regarding and amounts of goodwill impairment.Moreover, the

results show that firms with larger share pledging are less likely to recognize goodwill

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