Geographic distance and goodwill impairment

• Pages: 547-572
• Published date: 07 October 2019
• Date: 07 October 2019
• DOI: https://doi.org/10.1108/IJAIM-10-2018-0121
• Author: Joel Harper,Li Sun

Geographic distance and

goodwill impairment

Joel Harper

Farmer School of Business, Miami University, Oxford, Ohio, USA, and

Li Sun

Collins College of Business, University of Tulsa, Tulsa, Oklahoma, USA

Abstract

Purpose –The purpose of this study is to examinethe impact of asymmetric information, estimated as the

geographic distance between the acquiring firm and the target firm, on goodwill impairment following a

merger or acquisition.

Design/methodology/approach –This study uses regression analysis to investigate the research

questionsof this study.

Findings –This study finds that geographicdistance is positively related to the magnitude of current and

cumulative goodwill impairment.The results of this study still hold even after robustness checks for other

factors thataffect mergers and acquisitions and sources of asymmetric information.

Originality/value –This study extends and linkstwo distinct research streams: asymmetric information

related to geographicdistance studies in finance and goodwill literature in accounting.Specifically, this study

extends literature on the impact of geographic distance on various firm characteristics and contributes to

research regardingthe determinants of goodwill impairment, a major research stream in goodwill accounting

(Li and Sloan, 2016). To the best of the authors’knowledge, this is the first study that performs a direct

empirical test on the relation between geographicdistance (between the acquiring firm and the target firm)

and goodwillimpairment.

Keywords Goodwill, Goodwill impairment, Geographic distance, Mergers and acquisitions

Paper type Research paper

1. Introduction

The role of information in financial markets and the problems resulting from information

asymmetry are fundamental tenets in the economic and finance literature. Asymmetric

information, described by Akerlof (1970),Leland and Pyle (1977) and others, has been used

to explain the use of financial intermediaries (signaling by management to the market),

capital structure and other financialdecisions. In addition, information asymmetry provides

a basis for explaining the winner’s curse in initial public offerings as well as acquisition

premiums that acquiring firms pay to target shareholders (as measured by announcement

price reaction). Recent research examines the effect of geographic proximity on reducing

information asymmetry.For example, Baik et al. (2010) find that local institutional investors

and advisors earn higher returns, in part, to their informational advantages. Uysal et al.

(2008) find that there are higher returns to acquirers in local merger transactions and that

returns increase with the opacity of the target. In addition, Ragozzino and Reuer (2011)

examine the impact of geographic distance between the headquarters of the acquiring and

target firms on mergers and acquisitions(M&As) and document that geographic distance is

JEL classification –G34, M49

Geographic

distance and

goodwill

impairment

547

Received6 October 2018

Revised17 November 2018

Accepted2 December 2018

InternationalJournal of

Accounting& Information

Management

Vol.27 No. 4, 2019

pp. 547-572

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-10-2018-0121

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

www.emeraldinsight.com/1834-7649.htm

positively related to informationasymmetry. This information asymmetry tends to increase

the likelihood and the amount of an increased premiumpaid for the target’s shares, creating

a substantial amount of goodwill.If the premium paid for the target is not justified (acquirer

overpaid for target), then this goodwill eventually becomes impaired. The purpose of this

study is to examine the relation between geographicdistance and goodwill impairment.

We focus on goodwill impairment for the following reasons. First, goodwill is an

important intangible asset, which arises from M&As. Goodwill accounts for a significant

amount of a firm’s total net assets (Jennings et al.,1996). Hence, investors use information

about goodwill to evaluate a firm’s intangible assets and to estimate a firm’s future cash

flows (Hayn and Hughes, 2006). Second, the accounting standards (i.e. ASC 350-20[1])

require firms to perform an annualimpairment test on goodwill to determine if the fair value

is less than the carrying value. Hence, Filip et al. (2015) suggest that goodwill is the most

sensitive asset to a decline in firm value. Third, the frequency and magnitude of goodwill

impairment losses have drastically increasedsince 2008 (Darrough et al.,2014). As a result,

goodwill impairment has received increasedand significant attention. For example, Li et al.

(2011) argue that goodwill impairment is a leading indicator ofa firm’s future performance,

suggesting that such impairment contains critical information about a firm’s (future)

performance. Darrough et al. (2014) alsosuggest that goodwill impairment reflects the past

managerial performance following prior M&A activity. Finally, despite the surge of

attention on goodwill impairment, there is little empirical research on whether and how

certain characteristics (i.e. geographic distance) during M&A are associated with goodwill

impairment. The lackof empirical evidence motivates us to conduct this study.

Using a sample of firms that have completed M&As from 2002 to 2014, we identify 630

goodwill impairments withcomplete data to conduct our analysis. We find a significant and

positive relation between geographic distance (between the acquirer and the target) and

current and future goodwill impairment[2], measured as the magnitude of goodwill

impairment loss. Our results suggest that geographic distance increases information

asymmetry duringa M&A, leading to overpayment at acquisition and goodwillimpairment.

This is consistent with prior research, such as Ragozzino and Reuer (2011). We conduct

additional tests using alternativemeasures of distance, as well as tests on subsamples, to be

certain the results are robust with respect to alternative model specifications and

explanations. We beginby repeating our analysis usingan alternative distance measure and

obtain similar results. Second, we reexamine the main results across different subsample

periods. This test allows us to investigate the extent to which changes in macroeconomic

factors affect the impact of geographic distance on goodwill impairment over time. We

argue that the impact of geographic distanceon goodwill impairment should be stronger for

firms where the acquisition is an inter-industryacquisition or/and for small acquiring firms.

We find convincing evidence supporting our hypothesis about the direct relation between

distance and goodwill impairment. Finally, we predict and find that the results are largely

driven by firms with low managerial ability. This is consistent with prior research (Sun,

2016) suggesting that more-able managers better reduce goodwill impairment losses,

relative to less-able managers. Overall, results for all the robustness checks confirm our

central hypothesis.

This study makes several important contributions. First, this study extends and links

two distinct research streams: asymmetric information related to geographic distance

studies in finance and goodwill literature in accounting. Specifically, this study extends

literature on the impact of geographic distance on various firm characteristics and

contributes to research regarding the determinants of goodwill impairment, a major

research stream in goodwill accounting (Li and Sloan, 2016). To the best of our knowledge,

IJAIM

27,4

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