Determinants and Market Reaction of Assets Impairment in Taiwan

Abstract

On July 1, 2004, Taiwan's Financial Accounting Standards Committee of the Accounting Research and Development Foundation issued SFAS No. 35, Accounting for the Impairment of Assets. This accounting standard came effective in the financial year ending after December 31, 2005, with early application encouraged. Taiwan's SFAS No. 35 provides for accounting for assets impairment conservatively by recognizing impairment loss to reflect the market value of long-lived assets but not the unrealized gains of assets. SFAS No. 35 will affect accounting earnings, carrying amounts of long-lived assets, and, supposedly, the stock prices for listed firms in Taiwan. This paper examines determinants of assets impairment and its market reaction. First, we examine the determinants of early adoption of Taiwan's SFAS No. 35 for firms listed in the Taiwan Stock Exchange and the GreTai Securities Market. We investigate the motivation of adoption of assets impairment accounting in reporting purposes and operational purposes per literature. Our empirical results show that determinants for early adopters of Taiwan's SFAS No. 35 are the taking a ”big bath” purpose (the reporting motivation) and factors reflecting the accrual-based and cashflow-based recoverability of long-lived assets, such as changes in sales and changes in operational cash flows (operational motivations). Secondly, we examine factors affecting the ”amounts” of assets impairment in both reporting and operational perspectives. Our empirical results show the following: (1) For early adopters, the amounts of assets impairments are associated with only reporting motivations (the taking a big-bath purpose, the income smoothing purpose, and the changes in top management). (2) For non-early adopters, the amounts of assets impairment are associated with, not only the reporting perspective (the income smoothing purpose, the changes in top management), but also the firms' operational perspective (such as stock returns and sales growth). When analyzing the ”amounts” of assets impairment losses for five different types of assets (long-term investments, fixed assets, identifiable intangible assets, goodwill, and other assets), we find that impairment loss for goodwill is less likely to be associated with reporting motivation, probably because restoration of previously recognized impairment loss for goodwill is prohibited under SAFS No. 35. Finally, we examine market reactions to announcements of assets impairment in Taiwan. Our empirical tests of the shareholder wealth effects of impairment announcements reveal that, (1) the stock market reacts significantly and negatively to fourth-quarter impairment losses, but not to fourth-quarter unexpected earnings for early adopters of Taiwan's SFAS No. 35; and (2) the stock market does not react significantly to first-quarter impairment losses, but does react thusly to first-quarter unexpected earnings for all listed firms. The latter is consistent with Francis et al. (1996). In addition to Francis's explanations, we further interpret this result in terms of the same reporting dates for annual report and first-quarter report in Taiwan. Unlike the U.S. Securities Exchange Commission, which requires public firms to submit their 10-K on May 31 and their first-quarter 10-Q on April 15, Taiwan's Securities and Future Bureau (SFB) requires that annual report and first-quarter report be submitted on the same day (April 30) by public firms in Taiwan. Simultaneous announcements of annual report and first-quarter report may further explain our empirical results: the unexpected fourth-quarter earnings reflected in the previous year's annual report has no the information content at the end of the first quarter since information may have already been reflected in the beginning of the year. However, as expected, unexpected first-quarter earnings do have information content when they are announced. For assets impairment, on the contrary, investors react to the CPA-audited impairment losses in the annual report while no statistical evidence shows that investors react to CPA-reviewed first-quarter impairment losses.