Goodwill impairment loss and bond credit rating

• Pages: 2-20
• DOI: https://doi.org/10.1108/IJAIM-02-2016-0014
• Published date: 06 March 2017
• Date: 06 March 2017
• Author: Li Sun,Joseph H. Zhang
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Goodwill impairment loss and

bond credit rating

Li Sun

School of Accounting, University of Tulsa, Tulsa, Oklahoma, USA, and

Joseph H. Zhang

School of Accountancy, The University of Memphis, Memphis, Tennessee, USA

Abstract

Purpose –The purpose of this study is to examine the impact of goodwill impairment losses on bond credit

ratings.

Design/methodology/approach –The authors use regression analysis to examine the relationship

between goodwill impairment losses and bond credit ratings.

Findings –The empirical results show a negative relationship between the amount of goodwill impairment

losses and bond credit ratings, suggesting that rms with goodwill impairment losses receive lower credit

ratings. The authors perform various additional tests, including subsamples in good or bad market time,

changes analysis, rst time goodwill impairment rms vs subsequent impairment and the two-stage least

squares regression analysis to address potential endogeneity issues. The main results persist.

Originality/value –This paper links and contributes to two streams of literature: goodwill impairment in

accounting literature and bond credit ratings in nance literature. Whether a rm’s goodwill impairment

losses affect the rm’s bond credit rating remains an interesting question that has not been examined

previously. To the best of the authors’ knowledge, this is the rst study that directly examines the relationship

between goodwill impairment losses and bond ratings at the rm level.

Keywords Goodwill impairment, ASC 350-20, Bond rating

Paper type Research paper

1. Introduction

The purpose of this study is to examine the impact of goodwill impairment losses on bond

credit ratings. Anecdotal evidence suggests a negative relationship between goodwill

impairments and bond credit ratings. For example, Leido Holdings announced a $510m

impairment of goodwill on September 09, 2014. Moody, a major credit rating agency, made a

comment saying “Leido’s goodwill impairment is a negative development” on the same day

and downgraded Leido’s credit rating from Baa3 to Ba1 on November 3, 2014. This evidence

suggests that credit rating agencies take into account goodwill impairment when assessing

a rm’s creditworthiness. Despite the existence of anecdotal evidence, empirical evidence on

the impact of goodwill impairment losses on bond credit rating is still scarce. Some studies

(Gentry et al., 1988;Kim and Gu, 2003) suggest that bond ratings are largely determined by

nancial ratios including leverage, liquidity, protability, debt coverage and size. Other

studies (Bhojraj and Sengupta, 2003) suggest that corporate governance is also an important

determinant of bond ratings. Surprisingly, very few studies examine another possible bond

ratings determinant suggested by anecdotal evidence – goodwill impairment.

This study focuses on goodwill impairment for the following reasons: First, goodwill

accounts for a signicant amount of a rm’s balance sheet, and, thus, it is an important

JEL classication – G18, G24, M41

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

www.emeraldinsight.com/1834-7649.htm

IJAIM

25,1

2

Received 15 February 2016

Revised 19 April 2016

Accepted 24 April 2016

InternationalJournal of

Accounting& Information

Management

Vol.25 No. 1, 2017

pp.2-20

©Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-02-2016-0014

corporate asset (Jennings et al., 1996). Goodwill valuation is also a key input when

assessing a rm’s future cash ows (Hayn and Hughes, 2006). Investors extract goodwill

information to form appropriate perceptions concerning a rm’s intangible assets.

Second, Accounting Standards Codication 350-20 (ASC 350-20), Goodwill and Other,

requires the goodwill impairment test if there is a decline in the fair value of a reporting

unit. Thus, goodwill is regarded as the most sensitive asset to a decline in rm value

(Filip et al., 2015). Third, goodwill impairment reects managerial inability to extract

value from prior acquisitions. Fourth, goodwill impairment is a leading indicator of

future rm performance stemming from the failure to realize the expected benets of

prior acquisitions (Li et al., 2011). Lastly, the frequency of goodwill impairments has

drastically increased and goodwill impairment losses have become economically

signicant events (Darrough et al., 2014).

We rst identify a sample including goodwill impairment rms from 2002 to 2014. We

start at 2002 because ASC 350-20 became effective that year. Our empirical results show a

negative relationship between the amount of goodwill impairment losses and bond credit

ratings, suggesting that rms with goodwill impairment losses receive lower credit ratings.

We perform various additional tests, including subsamples in good or bad market times,

changes analysis, rst-time impairments vs subsequent impairments and the two-stage least

squares regression analysis (2SLS), to address potential endogeneity issues. Our main

results persist. Overall, the ndings support our conjecture that goodwill impairment losses

and bond credit ratings are negatively associated.

Our study makes the following contributions. First, the paper links and contributes to two

streams of literature:

(1) goodwill impairment in accounting literature; and

(2) bond credit ratings in nance literature.

Whether a rm’s goodwill impairment losses affect the rm’s bond credit rating remains an

interesting question that has not been examined previously. To the best of our knowledge,

this is the rst study that directly examines the relationship between goodwill impairment

losses and bond ratings at the rm level. Second, this study is incremental to the literature on

the determinants of bond rating (Bhojraj and Sengupta, 2003;Ashbaugh-Skaife et al., 2006).

Although this study does not attempt to construct a prediction model for bond rating, the

ndings from this study provide an avenue for future research on bond ratings. The

inclusion of goodwill impairment may help users of nancial statements better assess

the credit rating. Third, our study complements the ndings and associated interpretations

in Ramanna and Watts (2012) and Li and Sloan (2015). Both studies suggest that managers

exploit the discretion granted by ASC 350-20 to manipulate or even delay goodwill

impairment because goodwill impairment leads to negative consequences such as reduced

stock price and reduced compensation. This study suggests another motivation for

managers to manipulate or delay goodwill impairment losses by providing evidence that

goodwill impairment leads to lower bond ratings. Fourth, the evidence continues to suggest

that credit rating agencies may directly use the information on goodwill impairment losses

when assessing a rm’s creditworthiness. From a practical perspective, the results should be

of interest to policymakers who design and implement guidelines on goodwill impairment

and credit rating.

The rest of this paper is organized as follows. Section 2 presents the literature review and

hypothesis development. Section 3 describes the research design, Section 4 presents the main

results and additional analyses, and, in Section 5, we conclude this study.

3

Goodwill

impairment

loss