Insider Trading Preceding Goodwill Impairments

by Karl A. Muller III, Monica Neamtiu & Edward J. Riedl

Overview — Do insiders strategically sell their stock holdings prior to the accounting disclosure of goodwill impairment losses? While a number of recent studies provide evidence of insider trading prior to the announcement of earnings performance measures, a remaining puzzle is what types of information aggregated into reported earnings constitute the source of insiders' private information. This study provides evidence of a specific reporting item, goodwill impairments, about which insiders are able to strategically trade before its full discovery by the equity market and its recognition within the financial statements. Goodwill impairments represent likely sources of information for insiders to trade on for two reasons. First, they tend to be economically large, averaging 11.9 percent of the market value of equity during the sample period of 2002-2007. Second, managers likely have material private information regarding future cash flow estimates through their internal budgeting processes; and managers' private information advantage may be relatively long-lived due to goodwill impairment testing rules that may delay the accounting recognition of economic goodwill impairments. Key concepts include:

  • Up to 24 months preceding the announcement of goodwill impairment, insiders exhibit higher net selling behavior relative to firms not reporting such losses.
  • In addition, among firms reporting goodwill impairments, those with net selling among insiders exhibit significantly more negative abnormal stock returns relative to those not reporting net selling among insiders.
  • Overall, these results build on prior research investigating managers' discretion over goodwill impairments by providing evidence of a managerial incentive to delay the accounting recognition of goodwill impairments.

Author Abstract

We investigate whether insiders strategically sell shares prior to the disclosure of goodwill impairment losses. We provide evidence that insiders of goodwill impairment firms engage in abnormal selling of their shares quarters prior to the announcement of such losses. In addition, of firms recording goodwill impairments, we provide evidence that those firms with insiders selling prior to the announcement of the loss face significantly more negative abnormal returns. Our findings are robust to subsample analysis examining firms reporting goodwill impairments and having low quality information environments (i.e., delayed price discovery). This isolates a setting wherein observed strategic trading behavior more likely reflects insiders' private information regarding goodwill, as opposed to other (non-goodwill related) economic performance. Overall, the results are consistent with corporate insiders being able to profit from their private information relating to a specific financial reporting element, goodwill impairments, prior to its incorporation by the equity market or recognition by the firm's accounting system. Keywords: Goodwill, impairment, insider trading, SFAS 142. 55 pages.

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