On December 8, 2017, Luc Paugam (HEC Paris) presented his current research topic „Enforcement and Cash Flow Management to Delay Goodwill Impairments under IFRS” (co-authored with Andrei Filip, ESSEC Business School, and Gerald J. Lobo, University of Houston) at the WHU Research Seminar in Finance & Accounting.
Under IFRS, managers can use two approaches to increase the estimated recoverable value of a cash generating unit (CGU) to which goodwill has been allocated in order to justify not recognizing impairment: (1) make overly optimistic valuation assumptions (e.g., about discount rate, revenue growth, terminal growth rate), and (2) increase future cash flow estimates by increasing current cash flows. Because enforcement constrains the use of optimistic valuation assumptions the authors propose that the strength of enforcement influences the relative use of these two choices. Using an international sample of listed firms that report under IFRS, they document that the use of cash flow increasing management for firms that delay goodwill impairment is more positively associated with enforcement relative to a control sample that recognizes impairments. The authors also show that cash flow management to delay goodwill impairment is detrimental to future performance.