Managerial Decisions to Discontinue Operations and Future Firm Performance
57 Pages Posted: 7 Aug 2011
Date Written: August 3, 2011
Discontinued operations should reflect a strategic shift of resources that will help to improve future firm performance. A shift of fixed cost allocation from discontinuing or disposing of a line of business is discussed in management text books, and such decisions are complex and affect the performance of other existing operations because overhead costs are now allocated among a smaller number of operations. Thus, there are long-term implications involved in a change in marketing strategy or business operations. However, perceptions about the transitory nature of discontinued operations can potentially fool market-participants and lead them to ignore an important aspect of strategic decisions. My results suggest that while discontinued operations may be transitory, they contain the type of quality information that accounting standard setters wish to provide, and that can be used to evaluate the effectiveness of managerial decisions. Based on data from 1970 to 2008, I find that managers are more likely to report discontinued operations when per capita GDP declines, and they are less likely to report in recession years, suggesting general economic factors affect managerial decisions. Using data from 1993 to 2008, I find that CEO bonuses are positively associated with positive reports of discontinued operations but not with negative reports, which support the notion that compensation committees encourage objective managerial actions while attempting to mitigate disincentives to report negative discontinued operations. I also find compelling evidence that past negative discontinued operations are associated with future performance, measured by earnings, gross margin and operating cash flows, and market participants perceive positive implications of discontinued operations whether they are positive or negative. The usefulness of information contained in discontinued operations became much more pronounced after 1998, subsequent to SFAS 131 and SFAS 144, which changed the scope of the definition of discontinued operations.
Keywords: discontinued operations, future performance, managerial decisions
JEL Classification: M10, M41
Suggested Citation: Suggested Citation