Impaired Judgment: The Effects of Asset Impairment Reversibility and Cognitive Dissonance on Future Investment

41 Pages Posted: 22 Aug 2012 Last revised: 16 May 2015

See all articles by Kristina M. Rennekamp

Kristina M. Rennekamp

SC Johnson Graduate School of Management; Cornell SC Johnson College of Business

Kathy Rupar

Georgia Institute of Technology

Nicholas Seybert

University of Maryland - Department of Accounting & Information Assurance

Multiple version iconThere are 2 versions of this paper

Date Written: June 25, 2014

Abstract

This paper examines how the reversibility of the accounting effect of asset impairments affects managers’ investment decisions. We conduct two experiments in which participants act as CEO of a multi-division electronics company that suffers a large asset impairment at one of the divisions. Drawing on prior psychology research involving cognitive dissonance and decision reversibility, we predict and find that managers who are responsible for the decision to record the asset impairment invest more in the impaired division when the accounting effect of the impairment is reversible than when it is irreversible. This is consistent with the idea that reversible accounting effects encourage behavioral attempts to alter the cash flow outcome, while irreversible accounting effects encourage belief revision to rationalize the cash flow outcome. Also in line with cognitive dissonance theory, we show that managers who are not responsible for the decision to impair the asset, or managers who are given the opportunity to deny responsibility for the asset impairment, do not differ in their investment in the impaired division, regardless of impairment reversibility.

Keywords: accounting, standards, impairment, reversibility, reversals, managers, investment, R&D, IFRS, GAAP

JEL Classification: M4, M40, M41

Suggested Citation

Rennekamp, Kristina M. and Rupar, Kathy and Seybert, Nicholas, Impaired Judgment: The Effects of Asset Impairment Reversibility and Cognitive Dissonance on Future Investment (June 25, 2014). Available at SSRN: https://ssrn.com/abstract=2133520 or http://dx.doi.org/10.2139/ssrn.2133520

Kristina M. Rennekamp

SC Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-0500 (Phone)

Cornell SC Johnson College of Business ( email )

Ithaca, NY 14850
United States

Kathy Rupar

Georgia Institute of Technology ( email )

800 W Peachtree St NW
Suite 445
Atlanta, GA 30308-1149
United States
4043855713 (Phone)

Nicholas Seybert (Contact Author)

University of Maryland - Department of Accounting & Information Assurance ( email )

Robert H. Smith School of Business
College Park, MD 20742-9157
United States

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