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

Abstract

Using the adoption of SFAS 142 as an exogenous shock, we examine the effect of changes in financial reporting on firms’ internal information environment. SFAS 142 removed goodwill amortization and required firms to perform a two-step impairment test. We argue that complying with SFAS 142 induces managers to acquire new information and, therefore, improves managers’ information sets. Interviews with executives and auditors confirm this argument. Using a difference-in-differences design, we find that firms affected by SFAS 142 (i.e., treatment firms) experience an improvement in management forecast accuracy in the post-SFAS 142 period compared with those not affected. The increase is smaller for treatment firms with stronger monitoring mechanisms in the pre-SFAS 142 period and greater for firms with a higher likelihood of goodwill impairment. We further find that treatment firms with improvements in management forecast accuracy have higher M&A quality, internal capital allocation efficiency, and performance in the post-SFAS142 period than other treatment firms. Overall, our findings indicate that changes in external financial reporting can lead to better corporate decisions via their impact on the internal information environment.