Role of Financial Reporting and Auditing in Disciplining CEOs: Evidence from Goodwill Impairments

Abstract

According to accounting and auditing standards, external auditors and management must both independently monitor goodwill balance for any impairment. Therefore, goodwill impairment may contain valuable incremental information about the CEO’s ability which the board can utilize for CEO retention decisions. Consistent with this expectation, we find goodwill impairments lead to a large jump in subsequent CEO turnover. The turnover-impairment relationship varies with CEO power, auditor quality, accounting performance, and CEO-age and the information in goodwill impairment is incremental to the announcement period stock returns. Our analyses suggest that boards utilize the negative information in goodwill impairment in one of two ways. In the more severe cases, the incumbent CEO is dismissed; in other cases, their equity compensation is reduced which suggests that retention and pay act as alternative disciplining mechanisms. Our study highlights how the intersection of financial reporting and auditing can generate valuable information in disciplining CEOs.