Cognitive Dissonance as an Explanation of Goodwill Write-Offs

ABSTRACT

While agency theory has been an important part of accounting academic research, many researchers have suggested that other theories should also be considered. One such theory is the theory of cognitive dissonance. In this study, the authors develop competing hypotheses based on agency theory and the theory of cognitive dissonance regarding the decision to record an impairment of goodwill. Using an archival research methodology, they test the hypotheses on a sample of 2,274 firm-year observations. The results are consistent with the theory of cognitive dissonance even after controlling for variables that have been found to be significant under agency theory. The authors conclude that there is strong evidence to suggest that agency theory does not uniquely explain the results of management decisions as seen through financial reporting data.

KEYWORDS:

• Cognitive dissonance
• Agency theory
• Asset write-offs
• SFAS No. 142
• Goodwill

Funding

This study was supported by a grant from the CGA Ontario Research Excellence Fund.

Notes

1. To address these concerns, the FASB released SFAS No. 157, Fair Value Measurements (FASB [2006]), which defines fair value as the price that would be received to sell an asset or paid to settle a liability in an orderly transaction between market participants at the measurement date (i.e., exit values). However, SFAS No. 157 does not fully resolve the issues related to the measurement of fair values of the asset or liability for which an active market does not exist (e.g., goodwill). See also Benston [2008] for a discussion of SFAS No. 157.

2. However, many articles in the business press regard SFAS No. 142 as a political product (e.g., Weil [2000]).

3. As a sensitivity test, we use an incidence of loss (before write-down, if any) as an alternative proxy for big bath. The results are qualitatively and quantitatively consistent with those reported here.

4. We follow Francis et al. [1996] in defining top management. However, Graham et al. [2005] suggested that the CFO is mainly in charge of financial reporting choices. Thus, we repeat the analysis using only change in CFO as the measure of change in top management. The tenor of the results does not change.

5. Our final sample includes 305 observations with an ending goodwill balance of zero.

6. We want to express our gratitude to an anonymous referee for raising this question.