Managerial incentives, ownership structure and goodwill impairment : the case of public listed companies in Malaysia

Abstract

The introduction of International Financial Reporting Standards (IFRS) resulted in a significant change of the accounting treatment for goodwill. This change has been represented by the issuance of FRS 3 - Business Combinations, and FRS 136 - Impairment of Assets. These standards require goodwill to be tested for impairment and the impairment losses to be written off against income instead of amortizing it to earnings over useful economic life. Many countries have adopted these standards with the aim of enhancing the financial reporting quality including Malaysia which adopted Financial Reporting Standards (FRS) in 2006 and beginning 1 January 2006, Malaysian companies are required to comply with all Financial Reporting Standards (FRSs) including FRS 3 - Business Combinations, and FRS 136 - Impairment of Assets. Standard setters’ and regulatory bodies such as the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) stated that IFRS 3, which regulates business combinations and IFRS 36, which regulates impairment of assets were issued to provide users with more useful information about the underlying economic value of goodwill. However, the new standards have been criticized by academics and practitioners members for leaving significant rooms for management interpretation, judgment, and bias. Hence, the main purpose of this study is to examine the relationship between managers’ incentives and the magnitude of goodwill impairment losses reported by public listed companies in Malaysia. Additionally, this dissertation examines whether the impact of managerial incentives on the magnitude of goodwill impairment losses is moderated by ownership structure. Based on the agency framework it is expected that the magnitude of reported goodwill impairment is influenced by the managerial incentives. Three incentives have been identified, namely debt covenant avoidance, managerial compensation maximization, and political interventional avoidance. This dissertation employs secondary data of listed firms in the Bursa Malaysia derived from annual reports over five years spanning from 2007 to 2011. Based on Tobit multiple regression technique, it is found that managerial incentives to avoid violation of debt covenant is negatively associated with the magnitude of goodwill impairment, which support the debt covenants hypothesis. In addition, firm performance is found to be negatively related to goodwill impairment losses which suggests that firms with low performance record higher goodwill impairment losses and confirmed the Healy (1985) compensations hypothesis. While the direct relationship between firm size and the magnitude of goodwill impairment does not support the political cost hypothesis, the analysis of the moderating effect of ownership structure surprisingly show that, firms with highly concentrated owners, the larger the firm size the higher the amount of goodwill impairment losses, consistent with the political cost hypothesis. However, none of the incentives variables are significantly related to the magnitude of goodwill impairment in the presence of institutional owners.