The purpose of this thesis is to investigate the relationship between Chief Executive Officers' (CEOs') specific knowledge and the accounting method choice on purchased goodwill. The research investigates the central proposition that CEOs with greater specific knowledge of their firms' specialised assets are more likely to capitalise and amortise purchased goodwill than write it off to reserves. Specific knowledge is knowledge that is costly to transfer and observe. In the context of this research, specific knowledge pertains to knowledge of particular firms.
Specific knowledge is a source of incentives for and restrictions on the external reporting of specialised assets. Analytical arguments support the relationship between superior managerial knowledge and disclosure. The arguments show that the better the quality of information possessed by a manager about uncertain liquidating values of a risky asset, the greater the
likelihood that the manager will disclose that information, holding realisations constant. Recognition is a type of disclosure of an asset's future service potential, its estimated useful life and the expected pattern of economic benefits. Since purchased goodwill is a highly specific asset that has no value apart from a group of firms, markets and outside parties will not be able to assess the value of goodwill as well as specific human capital. Conversely, the lack of specific knowledge restricts managers' "accepted set" of accounting policies on goodwill. In a multiperiod setting, capitalisation of goodwill makes a firm accountable for its investment decisions in periods subsequent to the purchase.
This research focuses on the specific knowledge of CEOs. As goodwill is a strategic asset that arises at a group level, the responsibility for its assessment rests with an executive who has an overall view of the entity. In principle, a CEO is
at a vantage point to have the best view of strategic opportunities and challenges facing a firm. Furthermore, even if a CEO delegates decision rights to other agents, he/she assumes the responsibility for monitoring the exercise of these rights.
Since each method of goodwill accounting as examined in this study has offsetting effects on different contracting costs, it is difficult to arrive at consistent predictions of accounting choice using conventional contracting cost hypotheses. However, to test the robustness of the thesis' model, contracting cost hypotheses are tested for competing explanations of goodwill policy choice.
This thesis investigates goodwill policy choice of Singapore listed firms. Firms in Singapore can choose to either capitalise and amortise goodwill over an unrestricted period or write goodwill off immediately to reserves. The prevailing accounting standard in Singapore is based on International Accounting
Standard 22 which was issued in 1987. Data from annual reports of firms for the financial years ended in 1994, 1995 and 1996 are used. The study develops seven hypotheses that examines the relationship between knowledge-based variables and goodwill capitalisation. Both annual and pooled cross-sectional logistic regressions are carried out. The basis for classifying capitalising and noncapitalising firms is the accounting policy disclosure on goodwill.
The results of the logistic regression for the pooled sample support all hypotheses, except those pertaining to size and family variables. The results are robust to sensitivity tests of proxies used. The results of the annual regressions show similar trends as those of the pooled regression although some variables are less significant. Anomalous results in the multivariate tests may be caused by multicollinearity. Univariate tests support all hypotheses for each of the three years, with only one exception where
a variable is marginally past the significance threshold. In contrast, results of both univariate and multivariate tests do not support competing hypotheses. Since the thesis' model is based on one central proposition, factor analysis is performed to extract the underlying factors. The factors that emerge affirm the thesis' model. To test the association of each factor with goodwill choice, factor scores are regressed against policy choice using logit analysis. The results are significant and in the hypothesised direction.
Overall, the evidence from the different statistical tests supports the proposition that firms whose CEOs have greater specific knowledge of their firms' specialised assets will choose to capitalise and amortise goodwill rather than write it off to reserves. Discretion allows managers to communicate their specific knowledge of specialised assets. A possible implication of the evidence is the need to examine the role of accounting rules in
facilitating information flows from firms to markets. Discretionary policies are potentially an avenue for communicating firms' differential knowledge of their assets. A discretionary regime administered by agents of corporate governance have to be assessed against restrictive accounting rules that do not convey the differential levels of managers' specific knowledge.