Nonrecurring Charges Research Articles

Big Bath Accounting Following Natural Disasters

Practitioners and academics widely suspect that managers engage in “big bath” reporting behavior as a form of earnings management, but conclusive evidence of this behavior has been difficult to document due to the inherently endogenous nature of reporting the large nonrecurring charges necessary to engage in a big bath. We introduce a novel dataset of natural disasters to address this problem and argue that natural disasters provide an ideal exogenous shock to examine big baths. Consistent with opportunistic reporting, we find that, relative to both matched firms unaffected by a natural disaster and matched firms affected by the same natural disaster that do not report large, negative special items, big bath firms experience greater improvements in post-disaster earnings for multiple years and higher future stock returns. We also find that CEOs of bath firms receive relatively larger increases in bonus and cash compensation in the years following the natural disaster. Overall, our evidence suggests that managers take advantage of the occurrence of natural disasters by engaging in opportunistic big bath reporting behavior.

Admitting mistakes pays: the long term impact of goodwill impairment write-offs on stock prices

Prior studies find a negative stock price reaction after goodwill impairment write-offs both in the short term and in the long term. In 2002 the Financial Accounting Standards Board rules for accounting for goodwill changed. We examine data from after the rule changes and find that investors continue to perceive goodwill write-offs as negative events in the short term, but contrary to previous studies, we find that investors perceive goodwill write-offs as positive news in the long term. We provide evidence suggesting that firms incorporate all foreseeable non-recurring charges into the goodwill impairment. We examine the overall firm performance and find that it improves significantly post event. However, firm operating performance only slightly improves after the write-off. The overall firm performance improvements are due to decreased non-recurring charges in the years subsequent to the write-off.

Relevance of Goodwill Impairments to Cash Flow Prediction and Forecasting

This study examines the contribution of goodwill impairment information to the prediction and forecasting of future operating cash flows. Extending the framework of Barth, Cram, and Nelson, we find that explicitly including goodwill impairments incrementally improves 1-year-ahead cash flow prediction and forecasting. Improved cash flow forecasting is present over the entire 2001-2009 study period as well as for each year within the study window. In addition, goodwill impairments retain their significance and predictive power when other non-recurring charges (e.g., restructuring, asset write-downs, and merger and acquisition costs) are added to the model, both individually and aggregately, and when market-related information (i.e., change in market capitalization) is included in the model. While these findings are validated by in-sample prediction techniques, this study is also one of only a few studies to investigate the incremental, out-of-sample predictive power of non-current accruals on reported (as opposed to computed) operating cash flows. Analysts, investors, creditors, and others interested in future cash flows should separately consider goodwill impairment information, when available, to improve the accuracy of cash flow prediction and forecasting.

Do baths muddy the waters or clear the air?

We examine the information environments of firms following large, non-recurring charges (“baths”). We test competing hypotheses about the consequences of a bath—a bath either improves the information environment (the transparency hypothesis) or degrades it (the opacity hypothesis). Difference-in-differences analysis suggests that after a bath (1) earnings become smoother, (2) firm-level information asymmetry decreases, and (3) stock returns become more responsive to unexpected earnings. We interpret these findings as supportive of the transparency hypothesis. We also document that the relative improvement in the information environment is greater for baths that are not voluntary, consistent with managerial obfuscation prior to the bath.

The Persistence and Market Valuation of Recurring Nonrecurring Items

ABSTRACT: This study focuses on the persistence and market value implications of a subset of nonrecurring charges that are atypical due to repeated occurrence. The increased recurrence of supposedly nonrecurring items perhaps reflects managerial shifting of (more permanent) ordinary expenses to a transitory category or, alternatively, may reflect an environment where these items naturally occur more frequently. Either scenario suggests that these repetitive charges have future earnings implications dramatically different from truly nonrecurring events and should therefore be valued more like a recurring component of earnings. Consistent with this notion, we find that as the frequency of reporting negative special items increases (measured by the presence of multiple prior charges), the persistence of these items significantly increases with respect to future earnings. Our evidence also suggests that the valuation multiple on such charges increases with frequency. That is, the market values “recurring nonrecurring” items more like the other components of recurring earnings.

The association between institutional ownership and the likelihood of the firm reporting non-recurring charges

This paper examines the association between the level of institutional ownership and the likelihood of the firm reporting non-recurring or unusual charges. The increase in the magnitude and frequency of one-time charges has caused confusion and debate in the media (WSJ 2001). This paper posits that increased monitoring on the part of influential stakeholders (e.g., institutional investors) causes management to take corrective actions which leads to the reporting of these charges. If this is the case, non-recurring charges may be informative and value-relevant in the sense that they signal restructuring activity that will likely improve the degree of efficiency in which corporate assets are invested. The results support the hypothesis and indicate that the likelihood of management reporting non-recurring charges is positively and significantly associated with the level of institutional ownership.

History repeats itself: The acquisition method and nonrecurring charges

The Financial Accounting Standards Board issued Statement No. 141 (R) that replaces Statement of Financial Accounting Standard No. 141, Business Combinations. The new standard mandates use of the acquisition method, which requires expense treatment for acquisition-related transaction costs. Expense treatment is a departure from purchase accounting procedures, but is consistent with past guidance of Accounting Principles Board Opinion No. 16 for the pooling-of-interests method. Restoration of historical and controversial accounting procedures resurrects past outcomes. This study utilizes econometric techniques to predict outcomes of the acquisition method. Evidence indicates that expensing acquisition-related costs may improve transparent reporting. The results, based on 638 business combinations from 1994 through 1998, support the expectation that expense treatment for acquisition-related costs increases the likelihood that these costs appear more frequently and are greater in magnitude.

Joint accounting choices: an examination of firms’ adoption strategies for SFAS No. 106 AND SFAS No. 109

We provide insight into an argument that firms minimize the costs imposed by new accounting standards through their adoption choices. Focusing on two standards with potentially large impacts on both balance sheet and income statement accounts for many firms, we present evidence that firms chose their strategies for SFAS No. 106 (OPEB) and 109 (DTAX) jointly rather than separately. We also provide insight into how firms view recurring versus non-recurring charges, and how they weigh the tradeoff between a large one-time (income decreasing) charge against the smaller, but longer lasting effects of amortization.

RHODIA STANDS FAST

EMERGING FROM AN EXTREMELY depressed year and an aborted merger bid, the top managers at French specialty chemicals producer Rhodia were remarkably sanguine in presenting their 2001 results at the end of January. The company posted a net loss of $183 million, compared with a profit of $186 million in 2000. The loss, though, reflected heavy restructuring charges; excluding nonrecurring charges, the firm had a net profit of $59 million. Sales were down by 2% from the preceding year to $6.3 billion. And the company knocked $425 million off its corporate debt of roughly $2.6 billion at the end of 2000, in large part with the proceeds from asset sales. The strategic sale of assets is expected to continue this year: In a bid to reduce debt by at least $430 million, the company has hired consultants to advise it on the sale of noncore businesses. According to Pierre Prot, chief financial officer, Rhodia expects ...

Raw material costs hit chemical earnings

The initial rush of quarterly financial reports shows a wide divergence among chemical company earnings for firstquarter 1997. At the extremes, Arco Chemical's earnings dropped 55% and Monsanto's rose 32% compared with last year's first quarter. The main reason for the wide spread is that chemical companies that are highly dependent on petrochemical feedstocks had problems during the quarter. As Alan R. Hirsig, Arco Chemical's president and chief executive officer, points out, During the first quarter, high raw material costs, coupled with weak product pricing, compressed margins in virtually all of our businesses. Monsanto, on the other hand, had strong increases in two of its four operating units: chemicals, driven by Saflex plastic interlayer and performance materials, and food ingredients, through cost reductions. Operating profits at the company's agricultural products unit were also up sharply when nonrecurring charges are eliminated, leaving only the company's Searle pharmaceuticals unit with a d...

Repeated Accounting Write-Offs and the Information Content of Earnings

This paper examines the information content of earnings conditional on the presence of large nonrecurring or unusual charges. We also investigate the incremental information content of these special items. Of particular interest to us is whether investors view earnings differently after firms report large nonrecurring charges. Using quarterly Compustat data, we categorize firm-quarters according to the frequency with which firms report large special items during 1975-94 (defined as those in excess of 1% of total assets). We document the increasing frequency of reported special items, both positive and negative, during this period, noting that the increase in the frequency with which firms report negative special items (write-offs) is up to three times higher than the incidence of positive special items, and the divergence has increased. Three recent Wall StreetJournal articles exemplify the investing community's reaction to the announcement of multiple, or sequential, write-offs.