Financial Reporting Changes and Internal Information Environment: Evidence from SFAS 142

• In Event: Determinants of Voluntary Disclosure

Abstract

Using the adoption of SFAS 142 as an exogenous shock to the external reporting system, we examine the effect of a change in financial reporting on a firm’s internal information environment. SFAS 142 removed goodwill amortization and required firms to perform a two-step impairment test, which includes calculating the fair value of the reporting units at least annually. We argue that complying with SFAS 142 induces managers to acquire new information and, therefore, improves managers’ information sets and the internal information environment. Using managers’ earnings forecast accuracy as a proxy for the quality of the internal information environment and a difference-in-differences design, we find that firms affected by SFAS 142 (i.e., treatment firms) experience an improvement in the accuracy of earnings forecasts in the post-SFAS 142 period compared to those not affected (i.e., control firms). The increase in forecast accuracy is greater for treatment firms with weaker monitoring mechanisms, more goodwill, and a higher likelihood of goodwill impairment. Lastly, we find that treatment firms with improvements in forecast accuracy have higher internal capital market efficiency, higher M&A announcement returns, ROA, and Tobin’s q. Overall, our findings illuminate one of the mechanisms through which external financial reporting can enhance the internal information environment and improve operating efficiency.

Authors

• Qiang Cheng, Singapore Management University

• Young Jun Cho, Singapore Management University

• Holly Yang, Singapore Management University