The association between asset write-downs and future security returns
Date Issued
2008
Date
2008
Author(s)
Wang, Hsuan
Abstract
Nissim and Penman (2006), and Ohlson (2006) notice that extant GAAP mixes both balance sheet and income statement perspectives in measuring earnings and thus will decrease accounting earnings’ usefulness in securities valuation. For example, asset write-offs are recognized under balance sheet perspective, and they not only decrease current earnings, but will also increase the future earnings due to the reduction in subsequent depreciation expenses accompanied by the asset write-offs. The purpose of this study is to address whether investors understand the implications of decreased depreciation expense due to write-downs recognition, and hence the market will not react to the increase in reported earnings in the following year. The sample includes all U.S.A firms in Compustat database that recognized write-offs in their financial reports during the period of 2002-2006. The security return - earnings change regression results indicate that the decreases in depreciation expense accompanied by the write-down recognition is positively related to security return in the next year. The hedge return results also support the findings of regression analysis. As expected, hedge returns are significantly different from zero when based upon write-down amount or the decreased depreciation expense. This is consistent with that investors do not anticipate correctly the earnings increase after write-downs period. However, this study also examines the future security returns for a sample of firms reported goodwill write-down which has no effect on the subsequent earnings, and finds the amount of goodwill write-offs is positively correlated with security return in the next year. It means that the possibility of reversal of overreaction in the year of write-down cannot be ruled out. Overall, the results are consistent with that investors cannot assess the implication of asset write-offs for future earnings in an unbiased way. To avoid the misevaluation by investors, the accounting standard boards might want to consider adopting the pure income statement approach in earnings measurement (Ohlson, 2006).
Subjects
asset write-downs
balance sheet perspective
income statement perspective
earnings measurement
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