Evidence that Companies are not Analyzing Goodwill for Impairment as Required by SFAS142

Transcription

1 Evidence that Companies are not Analyzing Goodwill for Impairment as Required by SFAS142 DAVID E. VANCE Rutgers University School of Business Camden Working Paper Series WCRFS:

2 ABSTRACT: SFAS142 (2001) requires that goodwill be analyzed for impairment annually and written down if impaired. Impairment testing is complex and relies on many subjective factors. To users it is a black box analysis which gives companies an unprecedented opportunity to manage earnings. For example, in 2005 some 2,724 companies with $2.4 trillion of goodwill found only 0.54% of that goodwill impaired and in 2006 some 2697 companies with $2.4 trillion of goodwill found only 0.65% of goodwill impaired. If goodwill has value, it should generate rent comparable to industry norms. A reasonableness test for impairment would be to compare returns of companies with goodwill to these norms. In this study, 38,519 years of company operations for 48 industries were analyzed to develop industry norms. Of 2,730 companies with goodwill, 956 underperformed their industry by at least 10% and 95 underperformed by more than a standard deviation. The contributions of this article are to provide evidence that goodwill is not being properly tested for impairment and to develop a reasonableness test for determining whether a firm s goodwill is impaired. ACKNOWLEDGEMENT: This paper draws heavily on Compustat data in the WRDS data base service. Access to this data base service is funded in part by the David Whitcomb Center for Research in Financial Services. Access to such data is absolutely vital to researchers expanding the frontiers of knowledge in accounting, finance and related disciplines. Keywords: Goodwill, Impairment, Write-off, Intangible Asset 2

3 I Introduction Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets, (SFAS 142, 2001) provides that goodwill is not to be amortized, but rather tested for impairment. Proper impairment testing is significant factor in determining a company s financial position. In 2005, the 4,815 largest companies on Compustat had $54.4 trillion of assets and $2.3 trillion of booked goodwill or about 4.23% of total assets. In 2006, the 4,815 largest companies had $62.7 trillion of assets and $2.4 trillion of booked goodwill or about 3.91% of total assets. In 2005, some 256 companies with assets of $1.4 trillion and goodwill of $473 billion would have had zero or negative equity if goodwill were found impaired and written off. In 2006, 241 companies with $1.4 trillion of assets would have had zero or negative equity if $379 billion of goodwill were found impaired and written off. In 2005, another 88 companies with assets of $158 billion had negative equity of $35 billion and yet carried unimpaired goodwill of about $14 billion. In 2006, 83 companies with assets of $682 billion carried unimpaired goodwill of $25 billion. These facts seem at odds with the theoretical reason for goodwill which is to recognize intangibles which lead to superior performance such as management skill and learning. Companies with the attributes ascribed to goodwill should be profitable and profits should build equity. Impairment exists when the carrying value of a reporting unit with goodwill exceeds the fair value of the unit (SFAS ). Once impairment has been established, the extent of impairment must be measured. But goodwill only exists as a residual value so it can only be determined by subtracting the fair value of non-goodwill assets from the fair value of a reporting unit (SFAS ). The fair value of a reporting unit refers to the amount for which the 3

4 unit could be bought or sold between willing parties. Market prices are the best evidence of market value (SFAS ). Estimating the value of a stand-alone company is complex, and turns on assumptions about future revenue and expenses, industry trends and the market value of comparable companies. While SFAS142 (2001) invests more than 1,900 words describing impairment testing, it raises almost as many questions as it answers. Its complexity provides management with an unprecedented opportunity to manage earnings by writing off goodwill as needed to smooth earnings during good times or to retain goodwill on the books long after it has ceased to create value. This study analyzes 38,519 years of operations for companies with and without goodwill over the period 1995 to Norms of ROA performance are summarized by industry, based on the Fama and French (1997) classification model. The performance of companies with goodwill in 2005 was compared to these norms to identify companies that probably should have recognized that goodwill was impaired and written it down. The data also show that in 2005, 2,724 companies with $2.3 trillion of booked goodwill found only 0.54% of that goodwill impaired and in 2006, some 2,697 companies with $2.5 trillion of goodwill found only 0.65% of that goodwill impaired. This seems extraordinary if companies are faithfully testing goodwill for impairment as mandated by SFAS142 (2001). SFAS142 (2001) has presented analysts and other financial statement users with a black box impairment standard that gives companies an unprecedented opportunity to manage earning. The contributions of this study are to provide an evidence that companies are ignoring 4

5 the provisions of SFAS142 (2001) and to suggest a means of reasonableness testing management s impairment decisions. This paper is organized as follows, section II of this paper is the literature review, section III is the methodology, section IV is the empirical analysis and section V is the conclusion. II Literature Review Impairment Testing Goodwill booked pursuant to Statement of Financial Accounting Standards No. 141 Business Combinations, (SFAS 141, 2001 revised 2007) is the difference between the purchase price of a company and the fair value of net assets. As such, it is residual in nature and therefore impairment can only be measured by valuing the reporting unit, and the fair value of its assets at least annually (SFAS 142, 2001). A reporting unit is the lowest level for which financial information is maintained. A reporting unit is an operating segment or one level below a segment (SFAS ) as defined in FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information. If the carrying value of goodwill is greater than its fair value, then goodwill is impaired and must be written down to its fair value. To compute the fair value of goodwill, the reporting unit must be valued as a stand alone business. The fair value of the reporting unit, less the fair value of its non-goodwill assets, is the maximum value of goodwill (SFAS142, 2001). While these tests sound straight forward, there are numerous opportunities for manipulation. Valuation of a reporting unit as a stand alone entity depends on assumptions concerning revenue and expenses, market size and growth, competitors, new products, evolving technology, the value of services provided by a parent company such as information technology, treasury and 5

6 legal, as well as the amount of cash which must be reinvested in working capital, plant property and equipment and research and development to remain competitive. Valuation will also depend on the allocation of debt and tax liabilities or credits to the reporting unit. Burden on Goodwill The value of a reporting unit may decline for many reasons, for example a change in the regulatory environment, a technological break through, or unforeseen competition. These factors may or may not impair the value of non-goodwill assets. For example, a change in the regulatory environment may not affect the fair value of a pick-up truck or an office building, but may reduce the value of a business as a going concern. SFAS (2001) provides that nongoodwill assets should be tested before impairment before goodwill assets are tested for impairment. If non-goodwill assets are not impaired, the burden of enterprise decline will fall squarely on goodwill. Tracing Reporting Unit Assets Assets purchased with goodwill are rarely static. They are consumed, expanded, replaced and disposed of. Acquired companies are rarely left as purchased. They are split up or merged with other entities within a company. Capital is injected into these entities and withdrawn from them. Liabilities are incurred by reporting units and paid off. Corporate assets and liabilities that benefit the reporting unit must be allocated (SFAS ). This makes tracing goodwill and related assets to reporting units problematic (Hayn and Hughes 2006; Massaud and Raiborn 2003; Herz et. al. 2001). 6

7 Market Value While market price in actively traded markets is the best evidence of fair value, such evidence is rarely available. Even it is available, adjustments must be made for the control premium. If a minority of stock is actively traded, it probably sells at a discount to the value all the stock because the fair value of all the stock would include a premium for control (SFAS ). Present Value Methods The fair value of a reporting unit may be estimated using present value methods (SFAS ). The dividend discount model (DDM) of Williams (1938) is given in equation (1). This model sums the present value of all future dividends (DIV) using the firm s cost of equity r e as the discount factor. V 0 = E 0 (Div t ) (1) (1 + r e ) t This model assumes a stream of dividends can be forecast indefinitely into the future and also assumes a constant cost of equity. It is not especially useful for firms that don t pay dividends. The discounted cash flow model (DCF) shown in equation (2) is derived from DDM and discounts free cash flow (FCF) available to debt and equity holders to the present using the weighted average cost of capital (WACC). 4 t=1 T t=1 V 0 + net debt 0 = E 0 (FCF t ) + E0(V t + net debt) (2) (1+r WACC ) (1+r WACC ) 7

8 Forecasting FCF indefinitely into the future is difficult, so as a practical matter it is projected for a number of years at which time it is assumed the company reaches a steady state of growth and WACC is constant. This terminal value is given in equation (3). V t = E 0 [FCF t x (1+ g)] (3) (r WACC g) The residual income method (RIM) is based on DDM, but uses clean surplus accounting. Clean surplus accounting assumes all transactions that affect equity, except those with shareholders, are contemporaneously recognized in the income statement. Residual income shown in equation (4) is net income (NI) less a charge for equity equal to the cost of capital times the beginning period book value. RI t = NI t r e BV t-1 (4) Market value, V 0, is estimated as the sum of the present value of RI through some terminal date as shown in the first term of equation (5). As with free cash flow, it is difficult to compute residual income into the future indefinitely. Therefore, beyond the terminal date, all future value is estimated as the market value (V) at time t, less the book value (BV) at time t, discounted to the present at the cost of equity as shown in the second term of equation (5). T t=1 V 0 = E 0 (RI t ) + E 0 (V t BV t ) (5) (1 + r e ) t (1+r e ) t While Herz, et. al. (2001) laud these models as theoretically correct, they also discuss their limitations at length. For example, they all require forecasting revenue, expenses and reinvested capital over a long period of time. The DCF model requires forecasting a constant growth rate at some time in the future and the RIM model requires estimating market and book value at some time in the future. Terminal value can be a significant fraction of total value, so 8

9 reporting unit valuation is very sensitive to terminal value assumptions. There is also the question of whether the cost of equity of the parent should be used or the implied cost of equity of the reporting unit. All models are sensitive to estimates of the cost of equity capital and there are at least three different methods of estimating the cost of equity capital (Vance, 2003). Reporting unit WACC will be a function of the liabilities allocated to it including non-interest bearing liabilities such as accounts payable, accrued payroll and deferred taxes. Since present value models are based on so many estimates, management has an unprecedented opportunity to shape the outcome to meet its needs. Multiplier Methods Use of revenue or earnings multipliers may be appropriate if data are available on comparable companies. As a practical matter, this means comparable companies must be publicly traded. Assuming data on companies in the same industry, with a similar economic model are available, another question arises. Are we to assume the reporting unit is to be valued as a privately held or a publicly traded company? This is a significant valuation issue because privately held companies trade at a 25% to 30% discount to comparable publicly traded companies. The reporting unit may never have been public and may not be large enough to go public. Even if it is large enough to go public it may not qualify for listing on a major exchange (NYSE, AMEX or NASDAQ National Market) in which case valuation may be impacted by lack of market makers, thin trading, and it may not qualify for federal pre-emption which means it would be subject to both state and federal securities regulation (Vance 2005). Again, management s assumptions as to which companies are comparable and whether the reporting unit is valued as a public or private company gives rise to considerable management discretion. 9

10 Black Box Earnings Management These factors make a single, objective, verifiable test of impairment difficult. Another factor which makes evaluation of impairment testing difficult is the paucity and low quality of reporting unit level information (Hayn and Hughes 2006). Esquivel and Gornik-Tomaszewski, 2007) suggests additional disclosure, but even the best disclosure is only likely to document management choices, not the range of alternative choices not taken. A process so highly dependent on management judgment and discretion opens the door to earnings management (Massoud and Raiborn 2003). As a result, the process looks like a black box to analysts and other financial statement users. Francis, et. al (1996) found that management was more likely to game write-offs for hard to measure assets like goodwill than they were to game write-offs of more easily measured assets like inventory, plant, property and equipment. Hayn and Hughes (2006), reported a lag time of 3 to 4 years between economic impairment of goodwill and its recognition. They also reported that for a third of the acquisitions they studied, goodwill impairment was not recognized for six to ten years after a decline in economic value. Their work provides additional support for the idea that earnings are being managed through the goodwill impairment process. Some analysts dismiss goodwill as a mere bookkeeping device. However, Hirschey and Richardson (2003) found goodwill write offs were an important signal of a company s future prospects. For example, impairment announcements were highly correlated with an immediate 3 to 3.5% drop in stock price. More interesting, they found that one year post announcement, stock prices were down an average of 11% implying that investors initially under-reacted to impairment disclosures. Market reaction to impairment decisions provides companies with a strong motive to manage earnings. 10

11 The objective of this paper is not to criticize or second guess SFAS142 (2001). On the contrary, the issue is whether SFAS142 is being scrupulously implemented. This issue is addressed through a macro analysis of goodwill impairment across a large number of companies. However, a market-wide or even industry-wide analysis of impairment is of little use to analysts or other financial statement users. Therefore, this paper goes one step further and develops a reasonableness tests that can be applied on a company by company basis. This reasonableness test is not meant to replace goodwill impairment testing, but simply identify companies which merit enhanced scrutiny. III Methodology While impairment testing appears like a black box to financial statement users, a reasonableness test can be developed by returning to first principles. Goodwill is presumed to be an asset pursuant to SFAS141 (2001 revised 2007). One characteristic of an asset is that it generates rent. Rent generating capability can be measured by return on assets (ROA) defined as operating income before depreciation and amortization divided by average assets. One expects the ROA of companies with and without goodwill to be distributed around some industry average. If a company s ROA is substantially less than the industry average its assets are not being utilized as productively as those with above average ROA. If goodwill is impaired, it may be a non-productive asset. The ability to generate earnings from assets directly impacts enterprise value. Therefore, ROA can be used as a proxy for relative enterprise value. As discussed previously, if non-goodwill assets are impaired, the burden of enterprise decline falls squarely on goodwill (SFAS ). 11

12 Equation (6) assumes earnings from all reporting units are aggregated in the numerator and goodwill as well as non-goodwill assets from all reporting units are aggregated in the denominator. For many companies, this represents the maximum detail available to investors and analysts. ROA = Earnings before interest, taxes, depreciation and amortization (6) Goodwill + Non-Goodwill Assets If goodwill is so small compared to non-goodwill assets that it does not affect ROA, then it may be immaterial to a financial statement users. On the other hand, if non-rent producing goodwill is great enough to depress ROA, assessment and write down of goodwill to its fair value is more important. Writing down impaired goodwill will tend to raise a company s ROA in subsequent periods. There is no guarantee that the reasonableness test described herein will identify impaired goodwill in every reporting unit. For example, a company with superior ROA could have impaired goodwill in a small reporting unit. The proposed reasonableness test does, however provide a performance threshold below which it is more likely that some or all of a company s goodwill is impaired. The first step in this analysis was to create industry norms by selecting companies from Compustat with at least $20 million in assets, a stock price of at least $1 and sales of at least $5 million. Ten years of operating data (1995 to 2004) were used to develop a baseline consisting of 38,519 years of performance. Companies were then classified into 48 industries using the Fama and French (1997) classification schema provided as Appendix A. The mean, median, quartiles and standard deviation for industry ROA were computed using all companies regardless of 12

13 whether they had booked goodwill. The ROA performance of 2,730 companies with goodwill for the year 2005 were then compared to industry norms for indications of impairment. IV Empirical Analysis Compustat reported 4,815 companies with assets over $20 million for At the end of 2005, about 2,730 of those companies had total goodwill of $2.36 trillion. Of the $109 billion of goodwill written off, six firms accounted for $96 billion of write offs. Excluding these six firms, all other firms with goodwill wrote off about $13.2 billion or about 0.54% of recorded goodwill. In 2006 some 2697 firms ahs $2.45 billion of goodwill and found only 0.65% impaired. See Table 1 Impairment Analysis. Such a low percentage of goodwill impairment strains credulity. INSERT TABLE 1 Table 2 Industry Performance is an analysis of ten year historical return on assets for each of 48 industry classifications. For example, return on assets of 13.96% for the Chems industry was based on 733 years of operating performance by companies which met the threshold for inclusion in this study and which were reported on Compustat. The standard deviation of ROA for this industry was 6.13% and the ROA of the first quartile was 17.82%. The median and third quartile performance for this industry were 11.69% and 9.73% respectively. Data in this table provide ROA norms which are used as the basis of reasonableness tests. INSERT TABLE 2 Table 3 Comparison to Industry Norms analyzes individual companies with goodwill against norms for their industry. For example, in 2005, Computstat reported 96 companies in the Chems industry and 74 of those companies had booked goodwill. Of the companies that had 13

14 booked goodwill, 30 had an ROA at least 10% below the long term industry mean of 13.96% as reported in Table 2. For the Chems industry 12 companies with goodwill were in the lowest quartile for the industry and the ROA for 5 companies with goodwill was more than a standard deviation below industry mean. INSERT TABLE 3 Table 3 also analyzes how firms would move toward the mean ROA if goodwill were written off. For example, if the 30 Chems firms which under performed the industry mean by at least 10% wrote off their goodwill, 8 of the firms would have a return within 10% of the mean. The remaining 22 firms in this category would still under perform the Chems industry by at least 10%. Overall, of the 2,730 companies with goodwill, 956 or about 35% underperformed their industry by at least 10%. These companies had $1.04 trillion in goodwill booked. A fair question is whether this goodwill is impaired. About 418 companies or 15.3% of those with goodwill had an ROA in the lowest quartile of long term industry performance. These companies had $304 billion of booked goodwill. Since the performance of these companies is well below historical norms, a reasonable person might conclude there is a prima facie case that this goodwill has been impaired. A prima facie case means it looks impaired and is presumed impaired, but that presumption can be rebutted by substantial management evidence. About 95 companies had an ROA that was more than a standard deviation below their industry mean. These companies had $41 billion of booked goodwill. A reasonable person might conclude that the performance of these companies is so far below historical norms that enterprise value has significantly diminished. Since the effect of SFAS142 (2001) is to attribute the decline 14

15 of enterprise value to goodwill impairment, there is a very high probability that the goodwill for these companies has been impaired. Whether a company underperforms industry norms by 10%, or is in the lowest quartile, or underperforms by a standard deviation or more, there is some level at which management s decision to continue to carrying goodwill should be subject to a very high level of scrutiny and justification. The 10% underperformance level might simply be the threshold at which management s burden to justify its actions increases substantially. Questions for future research include the benefits, if any, of codifying reasonableness tests as a standard auditing procedure, the level at which underperformance warrants additional disclosure, the impact of the business cycle on reasonableness testing, and the potential for litigation should users begin reasonableness testing management s impairment decisions. V Conclusion Evidence suggests that a significant number of companies with goodwill are not properly testing it for impairment under the provisions of SFAS142 (2001). Goodwill impairment testing involves comparison of the fair value of goodwill and related assets to their book value. If the fair value of a reporting unit less the fair value of non-goodwill assets is less than booked value of goodwill, then goodwill is impaired and must be written down to its fair value. Tracing goodwill and other assets to reporting units post acquisition and valuing a reporting unit involves many management judgments. The bases of these judgments are rarely disclosed in sufficient detail to allow analysts or investors to critically evaluate management s impairment analysis. Valuation complexity and lack of information means financial statement users are confronted with a black box analysis and companies have a significant opportunity 15

16 for earnings management. In fact, data in this and other studies provide substantial evidence that goodwill is not being properly tested. In 2005, approximately 2,724 companies with $2.3 trillion of goodwill found only 0.54% of that goodwill impaired. In 2006 some 2697 companies with $2.4 trillion of goodwill found only 0.65% of goodwill impaired. Such a low level of impairment strains credulity. One can construct a reasonableness test of whether goodwill is impaired by comparing a firm s return on assets to historical industry norms. Firm value is related to performance. When return drops below historical industry norms, enterprise value diminishes, and with it, the value of booked goodwill. This article does not attempt to replace the guidance on goodwill impairment outlined in SFAS142 (2001), nor does it purport to identify every instance in which goodwill is impaired. However, it does suggest a reasonableness test that auditors, analysts and others can use to determine whether decisions not to write down goodwill are reasonable. Companies that fall below industry norms should receive enhanced scrutiny when they claim their goodwill is not impaired. 16

17 Table 1 Impairment Analysis An analysis of the 4,815 largest companies in terms of assets on Compustat for 2005 and 2006 showed that 2,740 had booked goodwill in 2005 and 2701 had booked goodwill in Most of the dollar value of goodwill impairments for these two years can be attributed to six companies in 2005 and four companies in 2006 that wrote off more than a billion of goodwill each. The remaining 2,724 companies in 2005 wrote off only 0.54% of goodwill and the remaining 2,697 companies in 2006 wrote off only 0.65% of goodwill. Amounts are millions of dollars. In 2005, 2730 companies had $2,361,070.1 million of booked goodwill after $109,011.4 million was found impaired and written off. Description Companies Goodwill Amount Percent of Companies Percent of Goodwill Percent of Impairments Total impairments , % 4.41% % Impairments over $1 billion 6 95, % 3.88% 87.86% Impairments under $1 billion , % 0.54% 12.14% No recorded impairment 2,484 2,361, % 95.59% Total companies with goodwill 2,730 In 2006, 2701 companies had $2,449,465.7 million of booked goodwill after $29,243.0 was found impaired and written off. Description Companies Goodwill Amount Percent of Companies Percent of Goodwill Percent of Impairments Total impairments , % 1.19% % Impairments over $1 billion 4 13, % 0.55% 45.68% Impairments under $1 billion , % 0.65% 54.32% No recorded impairment 2,456 2,449, % % Total companies with goodwill 2,701 17

18 Table 2 Historical Industry Performance This is an analysis of historical industry performance in terms of return on assets for the ten year period 1995 to Industry classification is based on the Fama- French (1997) model. Years is the number of years of operating history available for a particular industry over the subject period. Industry Years Mean Std.dev Q1 Median Q3 Industry Years Mean Std.dev Q1 Median Q3 Aero % 5.81% 17.08% 13.80% 10.28% Hlth % 13.17% 21.48% 14.67% 9.58% Agric % 7.60% 15.06% 10.07% 5.08% Hshd % 9.45% 21.38% 15.69% 10.54% Autos % 9.43% 18.28% 13.36% 8.79% Insur % 8.11% 9.42% 4.25% 1.92% Banks % 3.20% 3.20% 2.60% 2.09% LabEq % 14.06% 19.11% 11.39% 3.15% Beer % 7.45% 20.56% 14.10% 11.53% Mach % 11.03% 18.27% 12.46% 7.27% BldMt % 9.76% 20.08% 15.08% 10.99% Meals % 8.52% 21.00% 15.79% 10.24% Books % 11.47% 20.75% 16.01% 11.47% MedEq % 18.21% 20.67% 13.58% 1.82% Boxes % 5.21% 18.65% 14.50% 11.81% Mines % 8.92% 20.24% 14.90% 10.18% BusSv % 19.78% 19.32% 10.94% 1.96% Misc % 11.62% 18.76% 10.77% 6.43% Chems % 6.13% 17.82% 11.69% 9.73% Paper % 7.48% 18.34% 13.42% 9.18% Chips % 15.65% 9.40% 1.18% -7.74% PerSv % 12.26% 24.42% 15.10% 8.11% Clths % 12.87% 21.13% 14.41% 8.65% Retail % 11.13% 20.44% 14.81% 10.46% Cnstr % 8.60% 16.40% 12.25% 6.38% RlEst % 9.02% 13.36% 8.11% 4.05% Coal % 11.27% 21.07% 10.77% 6.69% Rubbr % 7.25% 18.91% 13.96% 10.16% Comps % 17.90% 16.37% 8.75% -0.29% Ships % 10.04% 15.86% 11.88% 5.63% Drugs % 24.79% 18.45% 6.47% % Smoke % 24.44% 32.35% 21.42% 11.79% ElcEq % 15.86% 18.48% 12.94% 6.99% Soda % 7.86% 17.81% 14.21% 11.75% Enrgy % 12.03% 22.36% 16.71% 10.96% Steel % 7.86% 16.59% 11.37% 9.74% FabPr % 6.87% 16.13% 12.75% -3.81% Telcm % 13.83% 19.23% 12.63% 3.60% Fin % 23.09% 17.85% 9.08% 5.45% Toys % 14.96% 19.59% 13.61% 8.45% Food % 9.23% 19.74% 14.88% 10.22% Trans % 14.96% 18.44% 9.97% 8.73% Fun % 11.77% 18.75% 13.81% 9.61% Txtls % 9.83% 16.41% 12.86% 8.69% Gold % 14.04% 13.53% 8.15% 2.22% Util % 4.60% 13.08% 11.10% 9.41% Guns % 8.68% 16.21% 12.29% 8.76% Whlsl % 9.16% 15.56% 12.21% 6.58% 18

19 Table 3 Comparison to Industry Norms This table is an analysis of companies with goodwill that fall below industry averages. Here n is the number of companies in an industry, and m, it the number of those companies which have booked goodwill. For the columns headed As Reported, 10%+ is the number of goodwill companies that underperformed industry norms by at least 10%, lowest quartile is the number of companies with goodwill that fell in the lowest quartile of industry performance, and 1.0 σ is the number of companies that fell at least 1 standard deviation below the industry mean. For the columns headed If Goodwill written off indicates how many companies would under perform by 10%+, be in the lowest quartile or be 1.0 σ below norms if its goodwill had been written off in a prior period. Industry classification follows the Fama and French (1997) model As Reported----- If Goodwill written off As Reported----- If Gooodwill written off % % % %+ below Lowest below Lowest below Lowest below Lowest Industry n m mean Quart. σ mean Quart. σ Industry n m mean Quart. σ mean Quart. 1.0 σ Aero Hlth Agric Hshld Autos Insur Banks LabEq Beer Mach BldMt Meals Books MedEq Boxes Mines BusSv Misc Chems Paper Chips PerSv Clths Retail Cnstr RlEst Coal Rubbr Comps Ships Drugs Smoke ElcEq Soda Enrgy Steel FabPr Telcm Fin Toys Food Trans Fun Txtls Gold Util Guns Whlsl

20 Appendix A Industry classifications This appendix is based on the Fama and French (1997) industry classifications plus the classification of the omitted SIC code of 3690 classified as electrical equipment, ElcEq. SIC range Code Industry SIC range Code Industry Agric Agriculture Chems Chemicals BldMt Construction Materials Enrgy Petroleum and Natural Gas Toys Recreational Products BldMt Construction Materials Mines Nonmetallic Mining Enrgy Petroleum and Natural Gas Gold Precious Metals Rubbr Rubber and Plastic Products Mines Nonmetallic Mining Autos Automobiles and Trucks Coal Coal Clths Apprel Enrgy Petroleum and Natural Gas Rubbr Rubber and Plastic Products Mines Nonmetallic Mining Clths Apprel Cnstr Construction Clths Apprel Cnstr Construction Hshld Consumer Goods Cnstr Construction BldMt Construction Materials Food Food Products Boxes Shipping Containers Hshld Consumer Goods Hshld Consumer Goods Agric Agriculture BldMt Construction Materials Food Food Products Hshld Consumer Goods Soda Candy and Soda BldMt Construction Materials Food Food Products Hshld Consumer Goods Beer Alcoholic Beverages Hshld Consumer Goods Soda Candy and Soda BldMt Construction Materials Food Food Products Steel Steel Works, etc Soda Candy and Soda Steel Steel Works, etc Food Food Products FabPr Fabricated Products Smoke Tobacco Products Boxes Shipping Containers Txtls Textiles BldMt Construction Materials Autos Automobiles and Trucks FabPr Fabricated Products Txtls Textiles BldMt Construction Materials Clths Apprel FabPr Fabricated Products Hshld Consumer Goods Guns Defense Txtls Textiles BldMt Construction Materials Autos Automobiles and Trucks Mach Machinery Txtls Textiles Autos Automobiles and Trucks BldMt Construction Materials Mach Machinery Boxes Shipping Containers Comps Computers BldMt Construction Materials Mach Machinery BldMt Construction Materials ElcEq Electrical Equipment Hshld Consumer Goods Chips Electronic Equipment Paper Business Supplies ElcEq Electrical Equipment Hshld Consumer Goods Hshld Consumer Goods Paper Business Supplies ElcEq Electrical Equipment Boxes Shipping Containers Autos Automobiles and Trucks Paper Business Supplies ElcEq Electrical Equipment Books Printing and Publishing Toys Recreational Products BusSv Business Services ElcEq Electrical Equipment Paper Business Supplies Chips Electronic Equipment Books Printing and Publishing Comps Computers Chems Chemicals ElcEq Electrical Equipment Drugs Pharmaceutical Products MedEq Medical Equipment Hshld Consumer Goods Autos Automobiles and Trucks 20

21 Appendix A continued SIC range Code Industry SIC range Code Industry Comps Computers Meals Restaurants, Hotel, Motel ElcEq Electrical Equipment Meals Restaurants, Hotel, Motel ElcEq Electrical Equipment Retail Retail Autos Automobiles and Trucks Banks Banking Aero Aircraft Banks Banking Ships Shipbuilding, Railroad Eq Fin Trading Toys Recreational Products Insur Insurance Ships Shipbuilding, Railroad Eq Insur Insurance Hshld Consumer Goods RlEst Real Estate Guns Defense Fin Trading Autos Automobiles and Trucks Meals Restaurants, Hotel, Motel Guns Defense PerSv Personal Services Autos Automobiles and Trucks PerSv Personal Services Hshld Consumer Goods Meals Restaurants, Hotel, Motel Chips Electronic Equipment PerSv Personal Services LabEq Measuring and Control Eq Meals Restaurants, Hotel, Motel Chips Electronic Equipment PerSv Personal Services LabEq Measuring and Control Eq BusSv Business Services MedEq Medical Equipment Comps Computers Hshld Consumer Goods BusSv Business Services Misc Miscellaneous PerSv Personal Services Hshld Consumer Goods BusSv Business Services Toys Recreational Products BusSv Business Services Paper Business Supplies PerSv Personal Services Hshld Consumer Goods BusSv Business Services Clths Apprel PerSv Personal Services Misc Miscellaneous PerSv Personal Services Hshld Consumer Goods Fun Entertainment BusSv Business Services Fun Entertainment Hshld Consumer Goods Hlth Healthcare BldMt Construction Materials PerSv Personal Services Misc Miscellaneous PerSv Personal Services Trans Transportation PerSv Personal Services Trans Transportation PerSv Personal Services Trans Transportation PerSv Personal Services Trans Transportation BusSv Business Services Trans Transportation PerSv Personal Services Trans Transportation BusSv Business Services Trans Transportation Misc Miscellaneous Telcm Telecommunications Meals Restaurants, Hotel, Motel Util Utilities Meals Restaurants, Hotel, Motel Whlsl Wholesale Retail Retail Whlsl Wholesale Banks Banking Retail Retail Banks Banking Retail Retail Fin Trading Retail Retail Insur Insurance Retail Retail Insur Insurance Retail Retail RlEst Real Estate Retail Retail Fin Trading 21

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