臺大管理論叢 NTU Management Review VOL.29 NO.1

Earnings Informativeness of Long-Lived Assets Impairment Recognized and Reversals 202 1. Introduction Earnings informativeness has been identified as a major characteristic useful for describing the magnitude of the return-earnings relationship. Prior studies (e.g., Kothari, 2001; Lundholm and Myers, 2002; Ettredge, Kwon, Smith, and Zarowin, 2005; Orpurt and Zang, 2009; Choi, Myers, Zang, and Ziebart, 2011; among others) have investigated the determinants of the return-earnings relation and have found that the informativeness of current stock returns with respect to current/future earnings is influenced by the quality of disclosure. Owing to the continuous nature of the business operating cycle, a firm’s gradual realization that its current earnings suffer from long-lived asset impairment provides certain private knowledge about future earnings. Based on our understanding of the return-earnings relation, this study investigates how the recognition of long-lived asset impairment (hereafter asset impairment) influences the amount of current and future earnings that are embedded in current stock returns. Managers record assets as being impaired if the value of the firm’s assets decline below their carrying value. However, managers may or may not report an economic impairment if there are explicit (e.g., contractual) and/or implicit (e.g., perceived stock market effects) reporting incentives (Riedl, 2004). The recognition of asset impairment explicitly affects current income and implicitly influences future earnings reporting. On the one hand, recognition of asset impairment will cause the impaired firm to record unrealized impairment in income, resulting in a charge against current earnings. The impact of recognizing asset impairment in the income statement should be taken as noise impounded in current earnings. 1 We suggest that current earnings are less informative given the recognition of asset impairment. Meanwhile, the recognition of impairment should result in a more correct valuation for long-lived asset on the firm’s balance sheet. Future earnings, which better reflect the approximation of intrinsic economic value of the underlying impaired assets, is expected to give a better signal for stock returns which, in turn, enhances earnings informativeness. Based on the current and future earnings informativeness model suggested by Collins, Kothari, Shanken, and Sloan (1994) (i.e., the 1 Riedl (2004) suggests that long-lived assets typically do not have active markets, thus managers may provide an estimate of fair value based on the best available information. The impairment loss is then reported as a component of current income from continuing operations.