Changes in the accounting for goodwill : is impairment more value relevant than amortization?

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Changes in the accounting for goodwill: Is

Impairment more value relevant than

Amortization?

Master Thesis

Laye Mory Kourouma

0439274

First supervisor: Dr. G. Georgakopoulos

Second supervisor: Dr Sanjay Bissessur

First draft: August 24 2014

Final draft: August 28 2014

Master Accountancy & Control

Faculteit Economie en Bedrijfskunde

Universiteit van Amsterdam

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Acknowledgements

I would like to acknowledge everybody who gives me assistance in the completion of this master thesis.

I am very grateful to my supervisor, Dr. G. Georgakopoulos, for his support, useful comments and input throughout all the thesis process. I also want to thank my second supervisor, Dr. S. Bissessur for his valuable comments.

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Contents Pages Acknowledgements 2 Abstract 4 Introduction 5 Literature Review 8 Research Design 12 Hypothesis 12

Description of the models 12

Periods Observed 15 Data Sources 15 Sample Selection 16 Results 21 Descriptive Statistics 21 Correlations 26 Regression Analyses 27 Conclusion 35 References 36

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Abstract

The principal aim of this thesis is to investigate whether goodwill impairment is more value relevant than goodwill amortization. To reach this objective, I use the Ohlson model (Ohlson, 1995) to test the hypothesis stating that goodwill impairment is more value relevant than goodwill amortization. To provide empirical evidence for the testing of the hypothesis, I examined 4 samples (2002-‐2004, 2005-‐2007, 2008-‐2010 and 2011-‐ 2013). The sample “2002-‐2004” consist of European companies that only apply goodwill amortization and the three other samples consist of European companies that apply goodwill impairment. There are 4 samples because I segregate the sample period from 2005 to 2013 into 3 sub-periods. By doing so all the sub-‐periods will have the same length, this makes it possible to analyze the period 2005-2013 deeply by comparing the sub-‐periods within this period with each other but also to compare easily the sample for goodwill amortization (2002-2004) with the samples for goodwill impairment (2002-‐2004, 2005-‐ 2007, 2008-‐2010 and 2011-‐2013) because the period length of the samples are the same.

The results show that goodwill impairment is more value relevant than goodwill amortization in the first six years after adoption of IFRS 3 and that this value relevance is decreasing as time past to the level that it is not more relevant than goodwill amortization after nine years. Further, it is remarkable that the contribution of goodwill impairment in the explanatory power decreases over the time while that of goodwill amortization increases. An unexpected finding is the higher significance and contribution of the variable net income in the explanatory power of both equations (1) and (2).

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1. Introduction

Goodwill is defined as "the excess of the cost of the acquired company over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed" (APB Opinion No. 16, Paragraph 87). This is one of the many definitions of a well-known and very old term in the academic and accounting world. Leake (1914, p. 81) pointed out that the ‘‘word

‘Goodwill’ has been in commercial use for centuries’’ and cited a reference from the year 1571.

Below, you can find some of the many definitions of the goodwill which are almost the same. Goodwill is “the excess of the cost of an acquired enterprise over the net of the amounts assigned to assets acquired and liabilities assumed” (CICA, 2002).

In his paper “A political Economy of SSAP22: Accounting for goodwill” Bryer (1995, p. 286) defined goodwill as the difference between the market value of an entity at any point in time and the fair value (either the replacement cost, recoverable amount or net realizable value) of its net assets, including any separately identifiable intangible assets (such as trademarks, copyrights, patent rights)

Goodwill is the name accountants give to the difference between the price an acquirer pays for a business, and the value of the individual identifiable assets it acquires (Higson, 1998, p. 141)

Goodwill is the advantage or benefit, which is acquired by an establishment, beyond the mere value of the capital stock, funds, or property employed therein, in consequence of general public patronage and encouragement, which it receives from constant or habitual customers, on account of its local position, or common celebrity, or reputation for skill or affluence, or punctuality, or from other accidental circumstances or necessities, or even from ancient partialities or prejudices. Goodwill is “the value of a business or practice that exceeds the combined value of the net assets.” “Essentially, goodwill is “the favor won by the

management of a business from the public, and probability that old customers will continue their patronage” (Jerrold and Richards, 2005, p. 389)

Goodwill is the value attributed to such intangible assets (among others) as reputation, well-trained workforce, good contacts within the industry, favorable business location, and any

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other unique features of the company for which another company would pay in excess of the value of net assets shown in the balance sheet (Barber, 2001).

There are two different kinds of goodwill: Goodwill developed internally within the firm and purchased goodwill, which is acquired by the firm during the purchase or takeover of another firm. Goodwill developed internally consist of diverse factors like a company’s good name and reputation, an established customer base, dependable suppliers and employees, and the ability to obtain more value from assets than competitors (Henderson and Peirson, 1988; Jennings, LeClere, and Thompson, 2001).

Goodwill and its proper accounting treatment have been debated over the past years resulting in some accounting major changes worldwide. Both the FASB and IASB modified the rules to require impairment rather than amortization of goodwill. For example the issuance of SFAS No. 142 in June 2001 in the U.S. with an effective date for fiscal years beginning after December 15, 2001; and the adoption of IFRS in 2005 in Europe. In 2005 the IASB (2005)

adopted IFRS 3. This adoption completely changes the accounting treatment for goodwill in diverse countries around the world. Goodwill impairment replaces goodwill amortization because FASB (2001) and IASB (2005), respectively the accounting standard-setting bodies in the U.S. and Europe, claim that goodwill impairment is more value relevant than goodwill amortization for the market valuation of the companies.

The new rules are meant to provide a better picture of the value of the goodwill on the financials. However, it may be questionable whether these new rules are better than the old ones.

The principal aim of the present thesis is to determine whether goodwill impairment is more value relevant than goodwill amortization. Therefore, the research question is the following: Is impairment of goodwill more value relevant than amortization of goodwill?

The results show that goodwill impairment is more value relevant than goodwill amortization in the first six years after adoption of IFRS 3 and that this value relevance is decreasing as time past to the level that it is not more relevant than goodwill amortization after nine years. Further, it is remarkable that the contribution of goodwill impairment in the explanatory power decreases over the time while that of goodwill amortization increases. An unexpected finding is the higher significance and contribution of the variable net income in the explanatory power of both equations (1) and (2).

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The remaining of this thesis is structured as follows. The following section, present a summary of the previous literature. I then discuss my research method (including data collection, sample selection and variable definitions), present the results and, finally, outline the thesis’s conclusions limitations, and future research opportunities.

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2. Literature Review

Several studies have been conducted on the value relevance of goodwill impairment and amortization in different ways.

Jennings, LeClere, and Thompson II (2001) examined whether excluding goodwill amortization from the computation of earnings increases the usefulness of earnings data to investors. They found that earnings before goodwill amortization explain significantly more of the cross-sectional variation in share prices than earnings after goodwill amortization. Further their analysis provided evidence that, even when disaggregated from the remainder of reported earnings, goodwill amortization provides no explanatory power for observed prices beyond that of earnings before goodwill amortization. Overall, their results indicate that when investors approximate share value by capitalizing accounting earnings, perhaps as a prelude to further analysis, the goodwill amortization component of reported earnings can best be viewed as a source of noise. Thus, excluding goodwill amortization from corporate income statements under the new rules will not reduce the usefulness of earnings but, rather, may eliminate a source of noise in earnings as measured under previous standards. The paper of Jennings, LeClere, and Thompson II (2001) provide evidence that goodwill amortization is irrelevant to investors for their decision making process which is in line with the FASB and IASB’s point of view but contradictive to the results of Jennings et al. (1996).

In their paper “Goodwill and Amortization: Are they Value Relevant?” Churyk and Chewning Jr. (2003) investigate if goodwill is valued as an economic resource by the equity markets and, if so, whether or not goodwill amortization and the market value of the company are related to each other. The results of their analysis of data from the years 1992 through 1996 indicate that the relation between goodwill and the market value of equity is positive for all years examined and statistically significant in four of the five years. These results are consistent with their predictions and previous research and imply that investors value recorded goodwill as an asset. The relation between goodwill amortization and the market value of equity for the same period is negative, as predicted, and statistically significant in some years and in the analysis of data pooled across years. They interpret these findings to indicate that the market views goodwill as an economic resource with a declining value, and the decline in value is associated with the amortization recognized.

The introduction of Financial Reporting Standard (FRS) 11 in the UK in 1998 (which allowed an annual impairment review as an alternative to capitalization and subsequent systematic

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amortization of goodwill) has been the reason for Li, Amel-Zadeh and Meeks (2010) to study the value relevance of goodwill impairment and the information content of impairment announcements. Their findings show that goodwill impairment leads to economically significant reductions in market value of the company. They also provide evidence that market react negatively to goodwill impairment announcements. The negative effect is greater for companies with a higher proportion of assets carried as goodwill and for

companies that release little information prior to the announcement. Their findings provide also a confirmation on prior evidences that capitalized goodwill has a significant relation market value in the year of acquisition, but this relation decreases thereafter; and that capitalized goodwill is value irrelevant when it is systematically amortized.

The relation between accounting goodwill numbers and equity values are examined by Jennings et al. (1996). They find a negative relation between equity value and goodwill amortization meaning that investors value amortization as relevant to their decision making process but investors also consider amortization as an accounting number that decreases the value of goodwill, the value of the company and therefore also its share price. But they also recognize the weakness of their results indicating that the value decreasing of the goodwill is not the case for all companies or not as fast as assumed by the expected economic lifetime. This limitation does not really impact the evidence provided by the paper that goodwill amortization is value relevant to investors for their decision making process.

Using for their research, a model comparing the explanation power of the different earnings numbers, Moehrle et al. (2001) investigate the information content of goodwill accounting numbers. In contrast with the results of Jennings et al. (2001), they show that there is no significant difference between the explanatory power of earnings numbers excluding or including amortization of goodwill. This means that amortization is not a disturbing factor but their finding that goodwill amortization is not relevant to investors is in line with the results of Jennings et al. (2001), as including goodwill amortization does not increase the explanatory power of the model.

In their paper “The Impairment of Purchased Goodwill: Effects on the Market Value” Li and Meeks (2006) investigate the value relevance of goodwill in the UK. In line with the results of of Bugeja and Gallery (2006) they show that goodwill is value relevant but that this value decreases over time. Another finding of their research is that amortization is value irrelevant.

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This confirms the claim of the IASB and FASB that the goodwill impairment is more value relevant than goodwill amortization.

By using a valuation model, Chambers (2006) studies the effects of SFAS 142 on financial reporting; He examined both the value relevance of impairments and the effects of the elimination of goodwill amortization. In line with objectives of FASB, He finds that financial reporting quality has improved by using impairments but that the quality of reporting is lower as consequence of the elimination of the amortization method. The main conclusion of Chambers (2006) is that concludes that the accounting quality is increased because of the introduction of SFAS 142.

Based on the Exposure Draft that the FASB issued on SFAS 142, Churyk (2005) examines whether the elimination of the amortization of goodwill is appropriate and compares market valuations of goodwill. Her results provide evidence that goodwill at acquisition is almost never overvalued indicating that systematic amortization is not needed. But she shows that goodwill decrease in value in subsequent periods. Further, (Churyk, 2005) mentions that impairment of goodwill can be done when stock price decreases or when the book value of equity is greater than the market value of the company.

Analyzing the effects of the adoption of IFRS on the Swedish stock market, Hamberg et al. (2006) show that goodwill is more persistent under the impairment method than under the amortization method. Further, the test also the value relevance of the reported goodwill by using a trading strategy in which they buy stocks with relative high amortization costs and sell stocks with relative low amortization costs. They find that abnormal returns are earned only if investors did not incorporate the changes already in prices, because of the longer persistence of goodwill under the impairment method of accounting. The investors see the higher persistence of goodwill as new information, but the results are not significant. Overall, their conclusion is that the introduction of IFRS led to more relevant accounting information.

By comparing the association between goodwill accounting charges against income and firms’ economic investment opportunities in amortization and impairment regimes, Chalmers et al. (2011) examine in their article “Does a goodwill impairment regime better reflect the underlying economic attributes of goodwill?” the claim of Accounting standard-setting bodies that an impairment regime better reflects the underlying economic value of goodwill than

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systematic amortization. Their results show that the association between firms’ goodwill charges against income and the firms’ investment opportunities is stronger during the IFRS regime than the AGAAP regime meaning that the claim is justified.

In general, the results of the above studies indicate that goodwill impairment is more value relevant than goodwill amortization.

This thesis contributes to the existing literature by adding new features in several ways. First, it extends and complements existing literature by investigating the value relevance of the impairment and amortization of goodwill for the share price and the market value of the company. Second, this study adds insight to the ongoing debate over the impairment and amortization of goodwill by analyzing the impairment data of many European companies from the beginning of the effectiveness of IFRS 3 in 2005 until 2013. Third, the research in this thesis is international (the examined samples are made up of companies from different European countries). Fourth, it spans the entire implementation period of goodwill

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3. Research Design

This section describes the research design used to investigate the research question. The first sub-section presents the tested hypothesis. The sub-section “Models” discuss the models used to test the hypothesis. Further, the data and samples selection is outlined.

3.1 Hypothesis

The motivation of accounting standards setters such as the FASB (2001) and the IASB (2005) for issuing new accounting standards is the improvement of accounting information quality. An example of new accounting standards issue is the adoption of IFRS 3 in 2005. The IASB (2005) introduces IFRS 3 because it claims that goodwill impairment is more value relevant than goodwill amortization. Therefore, the main objective of this thesis is to investigate if this claim is justified. So the hypothesis of this thesis is as follows:

H: Goodwill impairment is more value relevant than goodwill amortization.

3.2 Description of the Models

Research on value-relevance investigate “the association between a security price-based dependent variable and a set of accounting variables”; if an accounting number is significantly related to the dependent variable, then it is regarded as value relevant (Beaver, 2002, p.459). Most of this kind of studies makes use of an accounting-based valuation model like developed in Ohlson (1995) and its later various versions (Barth, et al., 2001). The Ohlson model (Ohlson, 1995) interprets the market value of a company as a function of the book value of equity and earnings. So, I used the Ohlson model (Ohlson, 1995) to test the above hypothesis.

The original Ohlson model (Ohlson, 1995) is:

In above equation:

MVEit represents the market value of the firm’s equity, time t; BVEit is the book value of the firm’s equity, time t; and

it it it

it BVE NI

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NIit is the net income of the firm, time t;

The explanatory power of the model is the indicator of the value relevance. Investors will use accounting information to make decision if they think that it is useful. Useful accounting information has a positive and strong with the share price and market value of the firm meaning that the explanatory power of the model will be high in this case. But the explanatory power will be low if accounting information is not useful for investors to make decisions.

Ohlson model (Ohlson, 1995) has the advantage is that it allows other variables to be added to the basic model. This makes comparison between different models and different explanatory powers possible. The comparison helps to make a conclusion on the value relevance of accounting information in general and goodwill amortization and impairment in particular. For this reason, The Ohlson-model (Ohlson, 1995) is the appropriate model for the research question of this thesis, because it is able to compare the value relevance of a model containing the variable goodwill amortization with a model containing the variable goodwill impairment.

The hypothesis of this thesis is tested using a modified basic Ohlson-model (Ohlson, 1995). To compare the value relevance of goodwill impairment with that of goodwill amortization, I set up two models, one containing the variable goodwill amortization and the other containing the variable goodwill impairment. The equation of the model containing the variable goodwill amortization is as follows:

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In this equation (1), I defined AMORTit as the amount of goodwill amortization time t. MVEit, BVEit and NIit have been defined earlier in the original Ohlson model (Ohlson, 1995). To calculate the market value of the firms’ equity, I multiply the number of shares

outstanding by the share price of three months after the fiscal year-end. By doing so, I want to be certain that the financial statements are published and that the accounting information used by investors to make their decision are available to them. The variables are not deflated by the number of shares outstanding to control for size differences because the samples consist of companies with big European companies with almost the same size, so the size problem can be neglected. Otherwise, the size problem could be a limitation of this thesis.

it it it it it BVE NI AMORT MVE =

β

0+

β

1 +

β

2 +

β

3 +

ε

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The explanatory power of equation (1) should be higher if the variable goodwill amortization is value relevant to the investors for their decision making process. But the results of the research done by Moehrle et al. (2001) show that there is no significant difference between explanatory power of goodwill amortization and that of goodwill impairment, while the results of the research done by Jennings et al. (2001) show that there is a significant difference because the explanatory power of goodwill amortization decreases, meaning that goodwill amortization is a noise to the market value of equity. However, this comparison is outside the scope of this research. So, it will not be developed in this thesis.

The equation (1) of the model containing the variable goodwill amortization is compared to the equation of the model containing the variable goodwill impairment:

(2) In this equation (2), I defined IMPit as the amount of goodwill impairment time t. MVEit, BVEit , NIit and AMORTit have been defined earlier in the original Ohlson model (Ohlson, 1995) and equation (1). Again, the number of outstanding shares will deflate all variables. The market value of the firms’ equity is calculated as the multiplication of the number of shares outstanding by the share price of three months after the fiscal year-end.

The explanatory power of equation (2) should be higher if the variable goodwill impairment is value relevant to the investors for their decision making process. This is confirmed by Lapointe et al. (2009) but the results of the research done by Barskjö and Paananen (2006) show no evidence that the explanatory power of goodwill impairment is higher.

The hypothesis states that goodwill impairment is more value relevant than goodwill amortization. To test the hypothesis, the explanatory powers of equations (1) and (2) are compared with each other. If the hypothesis is not rejected, goodwill impairment is more value relevant than goodwill amortization but the rejection of the hypothesis means that goodwill impairment is not more value relevant than goodwill amortization. The significance of the variables AMORTit and IMPit is very important in the process of providing evidence for the hypothesis testing.

The following sub-section describes the periods observed for the testing of the hypothesis.

it it it it it BVE NI IMP MVE =

β

0 +

β

1 +

β

2 +

β

3 +

ε

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3.3 Periods observed

For the empirical research, I choose to observe the period from 2002 to 2013. I divided this period in four sub-periods:

The first sub-period 2002-2004 is set up to observe European companies which only applied goodwill amortization. This sub-period is chosen because 2002 is the year in which all

European companies use Euro, as reporting currency and 2004 is the last fiscal year before the implementation of IFRS 3.

The second sub-‐period 2005-‐2007, the third period 2008-‐2010 and the last sub-‐period 2011-‐2013 are set up to observe European companies which only applied goodwill impairment. These sub-‐periods are chosen to evaluate goodwill impairment on the longest that exist. I segregate the sample period from 2005 to 2013 into 3 sub-periods

because by doing so all the sub-‐periods will have the same length, this makes it possible to analyze the period 2005-2013 deeply by comparing the sub-‐periods within this period with each other but also to compare easily the sample for goodwill amortization with the samples for goodwill impairment because the period length of the samples are the same.

3.4 Data Sources

To conduct the empirical analysis of this thesis, I require data on book value of shareholders equity, goodwill, and net income from Compustat Global -Fundamentals Annual and data on share price, number of shares outstanding from Compustat Global - Security Daily. The main advantage of these databases is that there is a lot of data available on companies worldwide. To calculate the market value of the equity, I multiply the share price by the number of shares outstanding. The database Compustat does not include the line item goodwill

amortization/impairment but it records the goodwill figures. I measure goodwill

amortization/impairment figures as the difference between goodwill reported in successive years.

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3.5 Sample selection

Based on the period observed, I select the samples according to the following requirements: § Companies from all industries are represented.

§ Companies have to use euro as reported currency.

§ Companies have to report a non-zero amount of Market value of shareholders equity, Book value of shareholders equity, Net Income and goodwill

amortization/impairment.

§ Companies selected for sub-period 2002-2004 have to use amortization for the accounting of goodwill. Few firms report goodwill amortization; the sample for sub-period 2002-2004 is limited to firms with continuously declining goodwill. By doing so, it is possible to measure goodwill amortization directly as the difference between goodwill reported in successive years.

§ Companies selected for sub-period 2005-2007, 2008-2010 and 2011-2013 have to apply impairment for the accounting of goodwill.

§ The fiscal year of companies selected consisted of 12 months. Firms with fiscal year consisting of other months are excluded from all samples

§ Firms with missing amount of book value of equity, net income and goodwill amortization and impairment are excluded from all samples

§ Firms with negative book value of equity are excluded from all samples

§ Firms applying goodwill impairment are excluded for the sample of the sub-period 2002-2004

§ The samples comprise companies with financial year-ends at December 31 in order to produce a near common valuation date across firms. Firms with other than December 31 year ends are excluded from all samples.

§ Firms not applying goodwill impairment are excluded for the sample of the sub-periods 2005-2007, 2008-2010 and 2011-2013

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The above sample selection method resulted in a total sample of N = 332 for the sub-period 2002-2004, N = 698 for the sub-period 2005-2007, N = 1081 for the sub-period 2008-2010 and N = 1010 for the sub-period 2011-2013. I review the observations of the samples for extreme values but there is no extreme value, so I do not exclude observations from the samples.

Distribution Sample 2002-2004 per country per year

Country 2002 2003 2004 N Austria 1 2 1 4 Belgium 3 7 4 14 Germany 14 14 9 37 Spain 2 3 3 8 Finland 8 15 17 40 France 40 58 55 153 Great Britain 0 0 1 1 Greece 0 2 2 4 Ireland 2 2 3 7 Italy 4 4 6 14 Luxemburg 1 0 0 1 Netherlands 11 13 16 40 Portugal 3 3 3 9 Totaal 89 123 120 332

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Distribution Sample 2005-2007 per country per year Country 2005 2006 2007 N Austria 9 9 10 28 Belgium 16 16 16 48 Germany 44 44 45 133 Spain 13 13 12 38 Finland 15 15 15 45 France 72 71 72 215 Greece 5 4 6 15 Ireland 4 0 4 8 Italy 21 21 22 64 Monaco 1 0 1 2 Netherlands 27 27 27 81 Portugal 7 6 6 19 Sweden 1 0 1 2 Totaal 235 226 237 698

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Distribution Sample 2008-2010 per country per year Country 2008 2009 2010 N Austria 14 15 16 45 Belgium 19 18 20 57 Switserland 4 3 4 11 Cyprus 2 2 1 5 Germany 74 64 64 202 Spain 27 24 27 78 Finland 24 21 19 64 France 87 85 91 263 Great Britain 1 1 1 3 Greece 8 8 6 22 Ireland 8 8 9 25 Italy 51 46 47 144 Luxemburg 1 1 1 3 Monaco 1 2 2 5 Netherlands 46 38 42 126 Portugal 7 8 9 24 Slovenia 0 1 0 1 Sweden 1 1 1 3 Totaal 375 346 360 1081

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Distribution Sample 2011-2013 per country per year Country 2011 2012 2013 N Austria 17 14 15 46 Belgium 20 19 17 56 Switserland 4 2 3 9 Cyprus 1 1 1 3 Germany 69 60 56 185 Spain 28 23 20 71 Finland 20 19 20 59 France 93 80 83 256 Great Britain 1 1 1 3 Greece 7 7 6 20 Ireland 8 6 6 20 Italy 48 40 33 121 Luxemburg 1 0 0 1 Monaco 2 2 2 6 Netherlands 46 39 42 127 Portugal 9 8 8 25 Sweden 2 0 0 2 Totaal 376 321 313 1010

Please refer to the attachment “Data Master Thesis Laye Mory Kourouma” of this thesis for more details on the samples used for the empirical research. These details cannot be include in this thesis because of the size of it.

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4. Results

In this section, the empirical results (Descriptive Statistics, Correlations and Regression Analyses) are presented and discussed. The empirical analysis is based on 4 samples (2002-2004, 2005-2007, 2008-2010, 2011-2013).

4.1 Descriptive Statistics

Statistics Sample 2002-2004 (A)

Market Value Equity Book Value Equity

Mean 3485 Mean 1644

Standard Error 490 Standard Error 215

Median 208 Median 115

Mode 8373 Mode 11640

Standard Deviation 8923 Standard Deviation 3912

Sample Variance 79620888 Sample Variance 15302630

Kurtosis 16 Kurtosis 15 Skewness 4 Skewness 4 Range 65714 Range 26699 Minimum 1 Minimum 542 Maximum 65715 Maximum 26157 Sum 1157172 Sum 545834 Count 332 Count 332 Largest(1) 65715 Largest(1) 26157 Smallest(1) 1 Smallest(1) 542

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Statistics Sample 2002-2004 (B)

Mean 6639 Mean 3118

Mode #N/B Mode 240

Kurtosis 33 Kurtosis 21 Skewness 5 Skewness 4 Range 134818 Range 47429 Minimum 8 Minimum 203 Maximum 134826 Maximum 47226 Sum 4633890 Sum 2176269 Count 698 Count 698 Largest(1) 134826 Largest(1) 47226 Smallest(1) 8 Smallest(1) 203 Confidence Level (95,0%) 1056 Confidence Level(95,0%) 494

Goodwill Amortization Net Income

Mean 211 Mean 23

Median 3 Median 6

Mode 1 Mode 773

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Goodwill Impairment Net Income

Mean 200 Mean 489

Median 6 Median 110

Mode 0 Mode 501

Confidence Level (95,0%) 95 Confidence Level (95,0%) 94

Mean 6246 Mean 5155

Mode #N/B Mode 9948

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Mean 107 Mean 436

Median 2 Median 75

Mode 1 Mode 5027

Mean 7865 Mean 6282

Mode #N/B Mode 14293

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Mean 36 Mean 417

Median 0 Median 87

Mode 1 Mode 4842

Mean 6931 Mean 5054

Mode 833 Mode 4301

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Mean 78 Mean 443

Median 1 Median 89

Mode 1 Mode 501

4.2 Correlations

Correlation Sample 2002-2004

Market Value Equity

Book Value

Equity Goodwill Amortization Net Income

Market Value Equity 1,00

Book Value Equity 0,83 1,00

Goodwill Amortization 0,30 0,41 1,00

Net Income 0,15 0,02 0,73 1,00

Market Value Equity Book Value Equity Goodwill Impairment Net Income

Goodwill

Impairment 0,15 0,15 1,00

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4.3 Regression Analyses

The results of the regression analyses on the samples are reported in Table A through E. The results of the regression on the sample 2002-2004 are reported below:

Market Value Equity Book Value Equity

Goodwill

Impairment Net Income

Goodwill Impairment 0,27 0,21 1,00

Net Income 0,68 0,58 0,24 1,00

Net Income 0,60 0,55 0,40 1,00

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Table A: Results Regression Analysis Sample 2002-2004

Overall, the results on the variables BVEit, NIit and AMORTit are consistent. Except for 2002 (where the p-values of net income (0.86) and amortization (0.89) are greather than 0.01), the results on the variables BVEit, NIit and AMORTit are significant at the 1% level even in the pooled sample. This indicates that investors consider these accounting information numbers in their valuation of the firm. The results on the variables BVEit, and NIit are an expectation because the book value of equity and the net income are elements of the company’s value that are the property of the shareholders. However the results on the variable AMORTit is a

surprise especially for the pooled sample. The coefficient on goodwill amortization for the pooled sample (1.74) is the highest compared to those on the book value of equity (1.67) and the net income (1.68), This would mean that a change in goodwill amortization expense has more effect on the share price and the value of the company than a change in book value of equity or in net income has. This is not in line with the theory that higher expenses of

goodwill amortization decrease the market value of a firm’s equity. The reported adjusted R² of 71% is the explanatory power of the model. This means that the combination of the three variables (BVEit, NIit and AMORTit) in the model explains seventy-one percent of the share price or the market value of the company.

Table A

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N Intercept BVE NI AMORT

2002 89 Coefficients 505,82 1,42 0,07 -0,08 p-value 0,40 0,00 0,86 0,89 t statistic 0,85 9,28 0,18 -0,14 2003 123 Coefficients 192,32 1,39 5,74 4,26 p-value 0,68 0,00 0,00 0,01 t statistic 0,41 7,43 5,86 2,55 2004 120 Coefficients 253,43 0,55 8,58 6,38 p-value 0,18 0,00 0,00 0,00 t statistic 1,34 5,87 14,99 12,75 Pooled 332 Coefficients 335,43 1,67 1,68 1,74 p-value 0,24 0,00 0,00 0,00 Adj. R² t statistic 1,17 19,48 5,85 3,95 0,71 it it it it it BVE NI AMORT MVE =

β

0+

β

1 +

β

2 +

β

3 +

ε

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Table B presents the results of the regression on the sample 2005-2007. Table B: Results Regression Analysis Sample 2005-2007

Table B

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N Intercept BVE NI IMP

2005 235 Coefficients 173,49 1,26 6,21 1,39 p-value 0,54 0,00 0,00 0,00 t statistic 0,61 15,57 14,78 4,96 2006 227 Coefficients 711,39 1,03 6,42 0,50 p-value 0,03 0,00 0,00 0,17 t statistic 2,17 12,96 14,55 1,38 2007 236 Coefficients 660,50 0,76 5,24 0,00 p-value 0,02 0,00 0,00 0,97 t statistic 2,35 10,12 13,85 0,03 Pooled 698 Coefficients 608,45 1,08 5,35 0,26 p-value 0,00 0,00 0,00 0,06 Adj. R² t statistic 3,13 21,49 20,43 1,87 0,89

In above table, the results on the variables BVEit, and NIit are all significant at the 1% level. However the results on the variable IMPit is not consistent in the different years. The coefficient and the t-values on the variable IMPit decrease from 2005 to 2007 while its p-values increase. The coefficient on the variable IMPit (0.26) is not significant for the pooled sample indicating that a change in impairment expense results in a lower or no effect on the share price and the value of the company. This is not in line with the theory that higher expenses of goodwill impairment result in lower market value of a firm’s equity and share prices. The explanatory power of the model is the reported adjusted R² of 89%, which means that the combination of the three variables (BVEit, NIit and IMPit) in the model explains eighty-nine percent of the share price or the market value of the company. But it is interesting to note that Net income has the highest coefficient for all the years in this sample inclusive the pooled sample. So the contribution of the variable net income is the biggest in the explanation. it it it it it BVE NI IMP MVE =β0 +β1 +β2 +β3 +ε

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Comparison between Table A and Table B shows the following findings:

First of all, there are more than two times observations in the sample 2005-2007 (N = 698) containing firms applying goodwill impairment than in the sample 2002-2004 (N = 332) containing firms applying goodwill amortization. This difference can be explained by the fact that most of the European companies already apply goodwill impairment before 2005 the year in which goodwill impairment became effective by law.

Secondly, in Table A, the coefficient of the variable AMORTit increase through the examined year 2002-2004 while in Table B the coefficient of the variable IMPit decrease through the examined year 2005-2007 meaning that goodwill amortization becomes more significant while goodwill impairment becomes less significant in the explanation of the share price and the value of the company.

Finally, the adjusted R² of 89% reported in Table B is higher than the adjusted R² of 71% reported in Table A indicating that equation (2) explains better the share price and the market value of the company than equation (1) but this is due more to the variable net income than to the variables book value of equity and impairment.

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Table C: Results Regression Analysis Sample 2008-2010

In 2008, Table C shows that the results on the variable IMPit are insignificant (coefficient = -0.16, p-value = 0.59 > 0.01, t-value = -0.54). Further, the other results on the variables BVEit, NIit and IMPit are significant at the 1% level. The coefficient of the variable BVEit decrease through the examined year 2008-2010 while the coefficients of the variable NIit and IMPit increase through the same period meaning that net income and goodwill impairment become more significant while good impairment become less significant in the explanation of the share price and the value of the company. It is also remarkable that compared to the sample 2005-2007 (N = 698) the number of observations in the sample 2008-2010 almost has increased twice to 1081. However the adjusted R² of 72% reported in Table C is lower than the adjusted R² of 89% reported in Table B indicating that the variables BVEit, NIit and IMPit in the sample 2005-2007 explain better the share price and the market value of the company than those in the sample 2008-2010. Again, the variable net income has the highest coefficient.

Table C

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2008 375 Coefficients 788,64 0,76 1,30 -0,16 p-value 0,02 0,00 0,00 0,59 t statistic 2,35 20,65 7,92 -0,54 2009 346 Coefficients 1920,87 0,65 4,18 1,65 p-value 0,00 0,00 0,00 0,05 t statistic 4,68 14,39 10,89 1,97 2010 360 Coefficients 1353,67 0,59 3,46 3,37 p-value 0,00 0,00 0,00 0,00 t statistic 3,96 14,45 10,84 7,13 Pooled 1081 Coefficients 1356,05 0,73 2,27 1,07 p-value 0,00 0,00 0,00 0,00 Adj. R² t statistic 6,06 31,49 15,26 4,08 0,72 it it it it it BVE NI IMP MVE =β0 +β1 +β2 +β3 +ε

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Table D contains the regression statistics of the sample 2011-2013. Table D: Results Regression Analysis Sample 2011-2013

The results on the variables BVEit, NIit and IMPit are all significant at the 1% level. But the coefficients on the variable IMPit are all negative, indicating that an increase in impairment expenses result in a lower market valuation. This is consistent with the concept that higher impairment expenses lead to lower share price and market value of the company. Further, the adjusted R² of 63% reported in Table D is much more lower than the adjusted R² of 71% reported in Table A, the adjusted R² of 89% reported in Table B and the adjusted R² of 72% reported in Table C indicating that the variables BVEit, NIit and IMPit in the sample 2011-2013 do not explain better the share price and the market value of the company than those in the samples 2002-2004, 2005-2007 and 2008-2010.

The results of the regression on the sample 2005-2013 are presented below:

Table D

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2011 376 Coefficients 2180,52 0,63 2,04 -0,76 p-value 0,00 0,00 0,00 0,01 t statistic 4,66 15,32 7,59 -2,78 2012 321 Coefficients 2811,98 0,48 4,26 -2,72 p-value 0,00 0,00 0,00 0,00 t statistic 5,06 9,04 8,47 -4,97 2013 313 Coefficients 2828,12 0,68 3,79 -2,81 p-value 0,00 0,00 0,00 0,00 t statistic 4,60 11,84 7,82 -3,43 Pooled 1010 Coefficients 2582,53 0,64 2,83 -1,46 p-value 0,00 0,00 0,00 0,00 Adj. R² t statistic 8,12 23,22 12,94 -5,95 0,63 it it it it it BVE NI IMP MVE =β0 +β1 +β2 +β3 +ε

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Table E

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2005 235 Coefficients 173,49 1,26 6,21 1,39 (p-value) 0,54 0,00 0,00 0,00 (t statistic) 0,61 15,57 14,78 4,96 2006 227 Coefficients 711,39 1,03 6,42 0,50 (p-value) 0,03 0,00 0,00 0,17 (t statistic) 2,17 12,96 14,55 1,38 2007 236 Coefficients 660,50 0,76 5,24 0,00 (p-value) 0,02 0,00 0,00 0,97 (t statistic) 2,35 10,12 13,85 0,03 2008 375 Coefficients 788,64 0,76 1,30 -0,16 (p-value) 0,02 0,00 0,00 0,59 (t statistic) 2,35 20,65 7,92 -0,54 2009 346 Coefficients 1920,87 0,65 4,18 1,65 (p-value) 0,00 0,00 0,00 0,05 (t statistic) 4,68 14,39 10,89 1,97 2010 360 Coefficients 1353,67 0,59 3,46 3,37 (p-value) 0,00 0,00 0,00 0,00 (t statistic) 3,96 14,45 10,84 7,13 2011 376 Coefficients 2180,52 0,63 2,04 -0,76 (p-value) 0,00 0,00 0,00 0,01 (t statistic) 4,66 15,32 7,59 -2,78 2012 321 Coefficients 2811,98 0,48 4,26 -2,72 (p-value) 0,00 0,00 0,00 0,00 (t statistic) 5,06 9,04 8,47 -4,97 2013 313 Coefficients 2828,12 0,68 3,79 -2,81 (p-value) 0,00 0,00 0,00 0,00 (t statistic) 4,60 11,84 7,82 -3,43 Pooled 2789 Coefficients 1937,35 0,73 3,01 -0,38 (p-value) 0,00 0,00 0,00 0,01 Adj. R² (t statistic) 11,78 42,60 25,47 -2,75 0,68 it it it it it BVE NI IMP MVE =

β

0 +

β

1 +

β

2 +

β

3 +

ε

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Interesting at above table is the pooled sample because I have discussed the other parts of the table earlier. The results on the variables BVEit, NIit and IMPit are all significant at the 1% level. But the coefficient on the variable IMPit is negative, indicating that an increase in impairment expenses result in a lower market valuation. The adjusted R² of 68% reported in Table E is much more lower than the adjusted R² of 71% reported in Table A, meaning that the variables BVEit, NIit and IMPit in the sample 2005-2013 do not explain better the share price and the market value of the company than that in the samples 2002-2004. But this conclusion has to be taken with care because comparing two samples with different period (2004-2004 and 2005-2013) and numbers of observations (N= 332 for 2002-2004 and N= 2789 for 2005-2013) is not fair.

The hypothesis states that goodwill impairment is more value relevant than goodwill amortization. Based on the higher explanatory power of equation (2) in Table B over equation (1) in Table A, this hypothesis cannot be rejected. However, based on the increasing significance of the amortization variable and the decreasing significance of the impairment variable during the three years, it is difficult to conclude that goodwill impairment is more value relevant than goodwill amortization.

Based on the higher explanatory power of equation (2) in Table C over equation (1) in Table A, and the less significance of the impairment variable compared with the more significance of the amortization variable in two of the three years of either sample, I have to admit that it very difficult to not reject the hypothesis. Because of the higher explanatory power of equation (2) in Table C over equation (1) in Table A, I have to conclude that goodwill impairment is more value relevant than goodwill amortization.

The comparison of Table A with Table D shows that the explanatory power of equation (1) R² of 71% in Table A is higher over the explanatory power of equation (2) R² of 63% in Table D, and the insignificance of the impairment variable compared with the significance of the amortization variable in all the three years of either sample, the hypothesis can be rejected. I conclude that goodwill impairment is not more value relevant than goodwill amortization. The comparison of Table A with Table E shows that the explanatory power of equation (1) R² of 71% in Table A is higher over the explanatory power of equation (2) R² of 68% in Table E, and the insignificance of the impairment variable compared with the significance of the amortization variable in the pooled sample of either sample, the hypothesis can be rejected. I conclude that goodwill impairment is not more value relevant than goodwill amortization.

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5. Conclusion

The principal aim of this thesis is to investigate whether goodwill impairment is more value relevant than goodwill amortization.

The results of this thesis show mixed evidence. Comparing the sample with goodwill amortization to samples with goodwill impairment, the results shows consistent with my prediction that goodwill impairment is more value relevant than goodwill amortization in the first six years after adoption of IFRS 3 and that this value relevance is decreasing as time past to the level that it is not more relevant than goodwill amortization after nine years. Further, it is remarkable that the contribution of goodwill impairment in the explanatory power decreases over the time while that of goodwill amortization increases. This conclusion has to be taken with care because the sample with goodwill amortization has been analyzed for a shorter time (3 years) while the goodwill impairment is subject to a research period of 9 years. An unexpected finding is the higher significance and contribution of the variable net income in the explanatory power of both equations (1) and (2).

A main limitation of this thesis is the shorter time on which goodwill amortization is analyzed. Therefore, Future research can extend these tests of goodwill amortization and impairment with amortization data before 2002. The size problem of the companies used in the samples could be another limitation of this thesis.

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