The Effect of Regulatory Loop-Holes on the Choice to Discontinued Operations
48 Pages Posted: 14 Jan 2016
Date Written: January 12, 2016
In recent decades there have been several changes in the definition of discontinued operations in the U.S., suggesting that regulators and prepares consider them important. We examine the reasons that firms choose to discontinue operations and their performance after the changes. As in earlier studies of asset sales, we find that corporate diversification, poor performance and financial constraints affect decisions to discontinue operations. We also present evidence that these divestitures are usually part of an on-going restructuring, and that single-unit entities do occasionally announce discontinuations. In 2002, the definition of items that could be reported as a discontinued operation was broadened, which changed reporting behaviors. After that, there are many more reports, particularly with positive values, and the magnitude of the average announcement is much smaller. These findings suggest that loop-holes in the earlier regulation allowed managers leeway to classify this item to their advantage. We also find that before 2002, firm earnings and share price performance improved after the announcement of discontinued operations, particularly with negative values. But, after the regulatory change, profits decline following reports. In addition, we show that firms that announce positive-valued discontinuations are larger, have slow growth, high financial leverage and are more financially constrained than those making negative valued divestitures, suggesting that they are disposing of their most liquid or valuable assets. As expected, firms are more likely to discontinue operations when equity markets are expanding. But, announcements are also more common when the economy is weak, which is contrary to the widely-held Liquidity Hypothesis.
Keywords: Regulatory loop-holes, Discontinued operations, Corporate focus
JEL Classification: G34, G38, M41
Suggested Citation: Suggested Citation