Restructuring Charges Research Articles

Accounting Discretion: Use or Abuse? An Analysis of Restructuring Charges Surrounding Regulator Action*

Contemporary Accounting ResearchVolume 26, Issue 3 p. 673-699 Accounting Discretion: Use or Abuse? An Analysis of Restructuring Charges Surrounding Regulator Action* Daniel A. Bens, Daniel A. Bens University of ArizonaSearch for more papers by this authorRick Johnston, Rick Johnston The Ohio State UniversitySearch for more papers by this author Daniel A. Bens, Daniel A. Bens University of ArizonaSearch for more papers by this authorRick Johnston, Rick Johnston The Ohio State UniversitySearch for more papers by this author First published: 18 January 2010 https://doi.org/10.1506/car.26.3.2Citations: 36 * Accepted by Peter Pope. This research has benefited from the suggestions of two anonymous ref-erees and Peter Pope (associate editor); workshop participants at the University of Chicago, University of Pennsylvania, and Georgetown University; and Brian Bushee, Ken Cavalluzzo, Ellen Engel, Mary Margaret Frank, Miles Gietzmann, Steve Monahan, Abbie Smith, and Scott Whisenant. James Chyz and Rohit Singh provided valuable research assistance. Bens gratefully acknowledges financial support from the Ratoff Family Fellowship at the University of Arizona. AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinked InRedditWechat Citing Literature Volume26, Issue3Fall 2009Pages 673-699 RelatedInformation

Restructuring Charges, Regulatory Changes and the Accruals Anomaly

In this study, we examine the role of restructuring charges in the existence and subsequent weakening of the widely documented accrual anomaly. We find that prior to 2003 the significant positive abnormal hedge returns experienced by accrual based strategies were influenced by a subset of firms with high restructuring charges. After 2003, with the introduction of the Statement of Financial Accounting Standards No. 146 changing the accounting for restructuring charges, restructuring firms no longer experience significant abnormal returns thereby weakening the accrual anomaly. Our results suggest that the regulatory changes have had an effect on impairing the role of restructuring charges in the accrual anomaly by improving the market's ability to correctly assess the valuation implications of restructuring charges in the low accruals portfolios.

US Managers' Use of ‘Pro Forma’ Adjustments to Meet Strategic Earnings Targets

Abstract: The practice of reporting manager‐adjusted ‘pro forma’ earnings numbers in quarterly earnings press releases has attracted considerable attention in recent years in the United States. Prior research suggests that while some managers report these adjusted numbers to better reflect core earnings, others may use these earnings adjustments to meet strategic earnings targets on a pro forma basis when they fall short based on GAAP reporting standards. Assuming the latter motivation could potentially mislead investors, the difficulty lies in distinguishing the ‘good guys’ from the ‘bad guys.’ Using hand‐collected pro forma earnings data, we investigate the extent to which different types of earnings adjustments affect the spread between pro forma earnings and GAAP earnings from continuing operations. Moreover, we investigate which types of adjustments managers use to meet strategic earnings targets. In addition to the exclusion of one‐time items like restructuring charges, the results indicate that managers often exclude recurring expenses such as depreciation, research and development, and stock‐based compensation to meet these strategic targets. The exclusion of recurring items is especially indicative of aggressive pro forma reporting. Finally, we find that firms that report adjusted earnings numbers only sporadically are more likely than firms that adjust earnings figures on a regular basis to use pro forma reporting to achieve strategic earnings targets by excluding recurring items.

DEMAND COLLAPSES IN FOURTH QUARTER

IN JUST ONE QUARTER, U.S. chemical industry earnings went from mixed to miserable. The prevailing tone from company executives has been one of shock and dismay at the disappearance of demand during the fourth quarter. At Dow Chemical, the unraveling economy resulted in a 23.4% decrease in sales during a very difficult time for the firm. Even excluding a restructuring charge of $628 million, the company had a loss of $574 million compared with earnings of $805 million in the same quarter a year earlier. In a conference call with analysts, CEO Andrew N. Liveris reported on “one of the worst quarters we have seen in more than two decades.” Like many industry leaders, he pointed to outside factors. “The rapid demand destruction and unprecedented destocking throughout almost every value chain is something none of us has ever experienced,” Liveris said. “The impact of this global economic correction in the fourth quarter was inescapable.” Also ...

An Examination of SFAS 146 Restructuring Charges*

This study examines whether earnings management using restructuring charges has changed subsequent to the implementation of SFAS 146. My empirical results indicate a significant decrease in the magnitude of abnormal restructurings and a lower association between abnormal restructurings and big bath reporting behavior after the standard. These findings suggest that the reliability of restructurings has improved under SFAS 146. Furthermore, I investigate how the effect of abnormal restructurings on future earnings growth has changed after the FASB action. My results reveal that the association between abnormal restructurings and growth in next year's core earnings is more positive in the post-SFAS 146 regime. This suggests that more reliable abnormal restructurings reported under SFAS 146 are accompanied by a greater improvement in future operating performance than prior to the standard. Finally, my stock returns tests show that abnormal restructurings are negatively and strongly associated with subsequent returns in the pre-SFAS 146 period, while such negative association is weaker in the post-SFAS 146 period. Thus, investors' perceptions of the implications of abnormal restructurings for future earnings growth may have improved following the standard.

The shielding of CEO cash compensation from post‐acquisition earnings' charges

PurposeThis study aims to examine whether CEO compensation is shielded from the negative effects of restructuring charges and asset impairments following the acquisition of the controlling interest in the stock of another corporation.Design/methodology/approachRegression tests using CEO cash compensation as the dependent variable, and restructuring charges, goodwill impairments, and other asset impairments associated with a target firm as independent test and control variables.FindingsThe results indicate that CEO cash compensation is increased when an acquiring firm with respect to the target firm records restructuring charges. Goodwill impairments have no effect on CEO cash compensation.Research limitations/implicationsThis study is limited to the extent that it only considers CEO cash compensation. A future area of research is to examine the association of total CEO compensation and post‐acquisition earnings” charges. Shareholders encourage CEOs to proceed with synergistic restructuring following a merger/acquisition by increasing their compensation.Originality/valueThis study contributes to the literature by concluding that compensation committees consider the contextual nature of earnings” charges and the CEO's direct responsibility for the transaction in the determination of CEO compensation.

The value relevance of corporate restructuring charges

We document in this study that investors react positively to restructuring that is expected to be successful in improving firm performance. Investors’ reaction is significantly negative to unsuccessful firms when the magnitude of restructuring charges is high. Our results also show that investors’ reaction is significantly positive to restructuring that is intended to save costs through “workforce reduction” and “facility closings/consolidations”, but it is insignificant when restructuring is undertaken to recognize decline in asset values by asset write-offs and/or write-downs. Investor reaction is measured by 12-month buy-and-hold abnormal returns, whereas successful restructuring to improve the firm performance is based on the change in operating performance, measured by the industry-adjusted return on equity (ROE), over two subsequent years after restructuring.

Managers' Use of 'Pro Forma' Adjustments to Meet Strategic Earnings Benchmarks

The practice of reporting manager-adjusted 'pro forma' earnings numbers in quarterly earnings press releases has attracted considerable attention in recent years. Prior research suggests that while some managers report these adjusted numbers to better reflect core earnings, others may use these earnings adjustments to meet strategic earnings benchmarks on a pro forma basis when they fall short based on GAAP reporting standards. The difficulty lies in distinguishing the 'good guys' from the 'bad guys.' Using hand-collected pro forma earnings data, we investigate the extent to which different types of earnings adjustments affect the spread between pro forma earnings and GAAP earnings from continuing operations. Moreover, we investigate which types of adjustments managers use to meet strategic earnings benchmarks. In addition to the exclusion of one-time items like restructuring charges, the results indicate that managers often exclude recurring expenses such as research and development, depreciation, and stock-based compensation to meet these strategic benchmarks. The exclusion of recurring items is especially indicative of manager opportunism in pro forma reporting.

Accounting Discretion: Use or Abuse? Restructuring Charges - 1989-1996

This paper provides the first large sample empirical evidence on the extent to which restructuring charges are associated with earnings management. Further, the study examines whether this association changed following FASB action to curtail suspected restructuring related earnings management. We examine 247 restructuring charges recorded between 1989 and 1992, a time period when restructurings were increasing in frequency and virtually unregulated with respect to accounting guidance. We also analyze a sample of 112 firms that recorded restructurings in 1995 and 1996, a period following the FASB action to standardize accounting for restructurings. We use several empirical specifications to control for the portion of the restructuring charge attributable to fundamental economic performance and macro-economic factors. We then estimate a series of multivariate regressions to determine if the restructuring charge is associated with earnings management proxies, a time dummy for reporting regime change, and interactions between the two. We document a significant decrease in the magnitude of the average charge after the FASB action. In the pre-regulation period, we document associations between the excess component of the restructuring accrual and firm size, leverage and CEO changes; however these relations do not exist in the post-regulatory period. These results suggest that FASB action had a significant effect on curtailing earnings management via restructurings.

The effect of repeat restructuring charges on analysts’ forecast revisions and accuracy

The primary objective of this study is to examine the effect of prior restructuring charges on analyst forecast revisions and accuracy. We find evidence that analysts respond differently to first-time restructuring firms than to repeat restructuring firms. Analysts revise their forecasts of both one-year-ahead earnings and five-year long-term growth in earnings more negatively for first-time restructuring firms than for firms with prior charges. When we examine forecast errors in the year subsequent to the restructuring, we find that current charges complicate analysts’ earnings forecast task. We further find that the decline in analyst forecast accuracy is mitigated by prior charges within past two years.

Institutional Monitoring and Corporate Restructurings

We investigate the monitoring role performed by institutional investors in corporate restructurings. We hypothesize that institutional monitoring will (1) influence a firm's decision to restructure and (2) encourage restructurings that stop poor performance before it becomes too severe (i.e. pre-emptive restructurings) and that fix performance problems more completely (i.e. thorough restructurings). Consistent with these hypotheses, we document that the level of institutional ownership (changes in transient institutional holdings) is (are) increasing (decreasing) in the probability that a firm restructures. This result holds after controlling for other determinants of the restructuring choice, including existing internal corporate governance mechanisms. The association between institutional ownership and restructuring decisions is also robust after controlling for the possible endogeniety problem using a simultaneous equations approach. Among firms that restructure, we find the level of institutional ownership increases the probability that the firm's restructuring is pre-emptive (proxied by positive or negative prior growth in ROE). We also find that institutional holdings increase the probability that a firm undergoes a restructuring that is thorough (proxied by above or below the median value of scaled restructuring charges). As a whole, the results suggest that institutional investors play an important monitoring role in encouraging managers to make value maximizing restructuring decisions.

The Roles of Task-Specific Experience and Innate Ability in Understanding Analyst Performance

There is considerable debate in the literature about what analyst experience measures and whether analysts learn from their prior experiences. Extant research has argued that once an analyst's innate ability is considered, the general and firm-specific experiences of an analyst are not relevant to understanding his/her forecasting performance. This prior research posits that only the highest-ability analysts survive at the job and, as a result, performance is not a function of analysts learning from their experiences. Drawing on psychology-based research, we argue that previous measures of experience need to be expanded to not only include general and firm-specific experience, but also task-specific experience. We empirically test our ideas within the context of firms experiencing restructuring charges. Our results reveal that analysts' performance (i.e., forecast accuracy) around current restructurings is associated with both their innate ability and their task-specific restructuring experience. In addition, we find that forecast accuracy and task-specific experience are most highly correlated for those analysts who survive the longest and, thus, presumably have the greatest innate abilities.

GIVAUDAN AND IFF PLAN TO REVAMP

APPARENTLY THE NEW YEAR'S resolution at the world's two largest flavor and fragrance companies, Givaudan and International Flavors & Fragrances (IFF), is to trim the fat. Both firms have started 2006 with plans to streamline operations, mostly in manufacturing. IFF is cutting 300 positions, or 6% of its workforce, in manufacturing, sales, research, and administration. The company says it will take pretax restructuring charges of between $25 million and $30 million in its fourth-quarter 2005 and first-half 2006 earnings, almost solely in employee separation costs. These actions are a necessary part of our ongoing efforts to maintain and improve IFF's profitability in the economic environment in which we operate, CEO Richard A. Goldstein says. Givaudan, by mid-2007, plans to close plants in NewMilford, Conn., and Oconomowoc, Wis., and transfer production from these sites to facilities in Cincinnati, and in Devon, Ky. The company will take about $17 million in charges. ...

'Benchmark Beating' as Evidence of Earnings Management: Review of the Literature

Abstract: This paper synthesises a new strand of earnings management research that uses distribution of reported earnings to detect earnings management instead of using discretionary accruals (DACCR), the conventional proxy for earnings management. The theoretical foundation for benchmark beating approach is derived from the 'prospect theory' developed by Kahneman and Tversky (1979) which shows that losses are more displeasing than the equivalent gain when evaluated from a particular reference point. Three such reference points are identified in the 'benchmark beating' literature, namely (i) avoiding losses; (ii) reporting small increase in earnings; and (iii) meeting or just beating analyst forecasts. Review of the empirical literature shows that there is an unusual discontinuity around zero for earnings level, earnings change and analyst forecasts than expected. Managers use available flexibilities under GAPP like deferred tax expense, tax expense, stock repurchase, restructuring charge reversals etc. to manage earnings for the purpose of achieving earnings thresholds. Research shows that stock-based compensation packages offered to managers is an important motivation for managers to engage in meeting or beating earnings thresholds. However, corporate governance mechanism like shareholder protection constrains managerial ability to meet or beat benchmark. Limitations of 'benchmark beating' literature for standard-setters are identified and some future research directions are provided.

Information technology outsourcing and organizational restructuring: An explanation of their effects on firm value

This paper draws from behavioral finance theory to provide an alternative explanation to the efficient market hypothesis that investor under- and overreactions occur by chance. Hypotheses propose relationships between information technology/systems outsourcing (hereafter IT/IS) decisions on short- and long-term abnormal returns, while exploring the potentially confounding effect of organizational restructuring events that frequently follow such decisions. Using event studies techniques, it is found that although IT/IS outsourcing announcements are positively related to short-term abnormal returns, restructuring charges after the announcement moderate the relationship between the short-term effect of such announcements and long-term abnormal returns, so that long-term returns become negative when followed by organizational restructuring efforts resulting from IT/IS outsourcing.

Operational Restructuring Charges and Post‐Restructuring Performance*

AbstractFirms incur restructuring charges as a result of actions intended to improve their operating performance. However, there is little evidence on whether restructuring charges are associated with improved performance. We examine a sample of firms reporting restructuring in 1991‐93 and find that the restructuring firms' earnings increase over the levels immediately before restructuring. Compared with a control sample of firms that report no restructuring, the restructuring firms improve their earnings and operating income, but evidence for improvements in cash flow from operations is mixed. In regression analysis, we find that restructuring charges are significantly positively associated with post‐restructuring changes in earnings relative to the restructuring year, but this association is largely driven by firms with multiple restructurings and firms reporting losses in the restructuring year. We find no association between restructuring charges and post‐restructuring changes in earnings relative to the year before restructuring. Restructuring charges are significantly positively associated with post‐restructuring changes in operating income and cash flow from operations for firms with multiple restructurings. In summary, restructuring charges are associated with improved earnings, but our results suggest that restructuring in the early 1990s did not necessarily guarantee improved operating performance.

Discussion of “Operational Restructuring Charges and Post‐Restructuring Performance”*

Operational Restructuring Charges and Post-restructuring Performance examines an important and interesting issue. Atiase, Platt, and Tse (2004) investigate whether firms that report restructuring charges exhibit improved future performance. This question is relevant because one of the motivations usually cited by management for restructuring is to improve performance and create shareholder value. Therefore, determining whether restructurings are beneficial is important for evaluating management and making investment decisions.

The effect of corporate restructuring charges on employer contributions to profit sharing plans

In this study, we empirically examine whether firms remove restructuring charges from earnings for purposes of determining employer contributions to profit sharing plans. Understanding firms' non-executive compensation practices is important because compensation policies influence employee behavior and ultimately affect employees' incentives to increase shareholder value. We find that profit sharing contributions decrease as restructuring charges increase, indicating that firms do not shield profit sharing contributions from restructuring charges. Further, we find that firms are more likely to completely omit profit sharing contributions during restructuring charge years than during other years. In contrast to these results, but consistent with prior research, we find that cash compensation paid to the top executives of our sample firms is unaffected by restructuring charges. Finally, we construct several compensation asymmetry measures and find that firms treat the restructuring charge component of earnings asymmetrically for purposes of compensating different employee groups.

VOLUNTARY DISCLOSURE PRACTICES: THE USE OF PRO FORMA REPORTING

This article looks at how U.S. managers supplement GAAP earnings with pro forma reporting. Pro forma measures, which are not audited, are typically determined through an adjustment to GAAP‐based earnings. For example, a manager may choose to present an alternative to GAAP earnings that excludes period write‐offs and one‐time restructuring charges in order to present a more value‐relevant picture of the company's performance.The authors find that 77% of S&P 500 companies report pro forma results, and that pro forma measures are generally given greater prominence than GAAP earnings in corporate press releases. Based on the evidence, U.S. managers are using pro forma reporting strategically to affect investor perception of corporate performance. The SEC has recently issued rules to ensure that pro forma disclosure is not misleading. The authors present some guidelines on voluntary disclosure that might help forestall further regulation and preserve the ability to pursue this potentially informative practice.

The Market Valuation of Recurring Nonrecurring Items: The Case of Repetitive Restructuring Charges*

The Market Valuation of Recurring Nonrecurring Items: The Case of Repetitive Restructuring Charges*