Goodwill Impairment After M&A: The Associations With Target Firms’ Earnings Quality And Accounting Experts On Acquiring Firms’ Audit Committees

Abstract

Regulators and policymakers are concerned about the value of earnings quality, which is a major source of financial information for bidder decisions. Prior research also showed that earnings quality has an initial impact on merger and acquisition (M&A) deals but not following the M&A. In response to this concern and previous research, this study investigated whether acquiring a low-earnings quality target, as described in the first hypothesis, increases subsequent goodwill impairments. To estimate the quality of the target's earnings, the Dechow and Dichev (2002), modified by the McNichols (2002) model was used, as well as, the goodwill impairment data collect from 10-K forms filed with the Securities and Exchange Commission SEC. The study’s outcome showed that when acquiring a low-earnings quality target, goodwill is more likely to be impaired. Overall, the findings indicated that the target's earnings quality could be used to assess M&A deals by reducing future goodwill impairments. The second hypothesis examines the role of the audit committee's effectiveness—that is, the accounting-financial expertise of its members—on goodwill impairment recorded as a result of acquiring target firms. The "accounting financial experts" variable was used as a ratio of the number of accounting financial experts on its audit committee to the number of audit committee members on the board. The study contributes to the literature by providing evidence of the usefulness of earnings quality, especially when one company uses the financial information of another in making M&A decisions. Furthermore, it contributes to the extant literature on audit committee effectiveness by providing a better understanding of how accounting financial expertise increases the likelihood of recognizing post-M&A goodwill impairment. The findings are useful to investors, analysts, auditors, and regulators who are interested in learning more about goodwill impairment.