The effect of SFAS No. 142 on the ability of goodwill predicting future cash flow

This study investigates the effects of Statement of Financial Accounting Standard No.142 (SFAS No.142) on the ability of goodwill to predict future cash flows. SFAS No. 142 allows substantial unverified managerial discretion and leads to a significant magnitude of economic impact on financial statements, resulting in critical debates over the consequence of its adoption. I find that the ability of goodwill to predict future cash flows has improved since the FASB adopted SFAS No.142. Further analysis documents that goodwill's explanatory power for future cash flows is enhanced in the partitioned sample with a high level of managerial discretion, but not in the sample with a low level of managerial discretion in the pre-SFAS No.142 period. Overall, contrary to the position of critics of SFAS No.142, results support the view taken by the FASB and proponents of SFAS No.142: expanding managerial discretion with the adoption of SFAS No.142 improves managers' ability to signal future cash flows and this positive effect is stronger than the offsetting the effect of opportunistic reporting.