Top Executive Background and Financial Reporting Choice: The Case of Goodwill Impairment

by Francois Brochet & Kyle Welch
 
 

Overview — In the management literature, some theories hold that corporate actions and strategic choices can be partially predicted by knowing the functional background of executives. The authors provide evidence on how CEOs and CFOs who were former investment bankers, auditors, and private equity/venture capital executives managed decisions around goodwill impairments (essentially goodwill charge-offs)—a complex accounting choice involving a high degree of managerial discretion. Research by HBS professor Francois Brochet and doctoral candidate Kyle Welch. Key concepts include:

  • Results of the research suggest that executive functional background is a significant explanatory factor of goodwill impairment reporting, and that its effect is better understood in the context of upper echelons theory and agency theory.
  • The results can help researchers explore the role of the individual manager in explaining financial reporting choices and also help them to control for executive-level characteristics when investigating determinants of goodwill impairments.
  • Since executive background is an actionable variable for corporate boards, a better understanding of its role in executives' financial reporting choices can be informative to those who monitor executive reporting.

Author Abstract

We study the role of executive functional background in explaining goodwill impairment choices. We focus on top executives (CEOs and CFOs) whose employment history includes experience in investment banking, auditing, or private equity/venture capital. On average, we find that former auditors are significantly more likely to impair goodwill. However, further investigation reveals that former auditors and investment bankers are more likely to impair goodwill when their reputation concerns are low, suggesting that those executives are subject to their own opportunistic motives. We also find that the greater propensity of former auditors and investment bankers to report goodwill impairments is concentrated in firms that have a board member with a similar background. Finally, we find that former investment bankers are more likely than other executives in our study to disclose pro forma earnings excluding goodwill impairment. Overall, our results suggest that executive functional background is a significant explanatory factor of goodwill impairment reporting and that its effect is better understood in the context of upper echelons theory and agency theory.

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