Financial Crisis and Impairment Recognition in Non-Financial Assets.
| Autor | Gaio, Cristina |
1 Introduction
During 2008 and 2009, European companies faced probably the worst financial crisis ever. The 20082009 financial crisis, commonly referred to as the subprime crisis, led to strong turbulence in the financial markets and a sharp contraction of the economy, considered to be the largest economic contraction since the Second World War (Barth & Landsman, 2010). This crisis had a heavy impact on the European business environment, being considered by many as the worst crisis since the Great Depression of 1930 (Gunn, Khurana, & Stein, 2018).
Financial crises affect not only the financial sector, but also the business sector. According to Kousenidis, Ladas and Negakis (2013), financial crises affect firms through two interacting pathways: unfavourable macroeconomic conditions lead to a decline in firms' sales and level of operational performance; and the financial collapse of banking and capital markets limits financing opportunities by reducing firms' liquidity. Although financial institutions may have been the most affected by the 2008-2009 financial crisis, the effects of the crisis also spread to non-financial firms (Goncalves, Gaio, & Robles, 2018). In this period, many companies had to review their businesses, as well as the value of their assets, since these might not have been reflecting their true economic value.
In fact, in periods of economic recession, there is a high probability of rapid deterioration of assets and the decision to recognize impairments is of the utmost importance, as negative changes in the economy (such as a financial crisis) are one of the external indications referred to in the provisions of IAS 36--Impairment of Assets, which may imply lost economic return capacity of assets.
The consequences of macroeconomic changes, specifically turbulent economic periods, on the quality of accounting information are still poorly explored (Filip & Raffournier, 2014). Studies analysing the impact of the financial crisis on the recognition of impairments in non-financial companies and, in particular, in non-financial assets, remain scarce. Examples of these scarce studies are those of Vanza, Wells and Wright (2011), Wirtz (2013), Yammine and Olivier (2014) and Zhang (2011). Additionally, most of the literature focuses on analysing goodwill impairments, and the remaining non-financial assets do not tend to be investigated, despite their predominance among corporate assets. There are even fewer studies analysing companies in countries with greater financial fragility, which, as such, may feel the negative impact of a financial crisis on their performance levels and on the economic value of their assets more intensely. Examples of such studies are those of Albuquerque, Almeida and Queiroz (2011), Izzo, Luciani and Sartori (2013) and Sant'Ana, Goncalves, Guerreiro and Nobre (2016). On the other hand, the scarce studies there are do not present consensual conclusions.
Thus, this study has two major objectives. First, it aims to analyse whether European listed companies recognized more impairments in non-financial assets during the 2008-2009 financial crisis, and if, when recognizing impairments, the amount considered, i.e. the magnitude of the impairment, was higher due to the negative consequences of the crisis. Secondly, it seeks to analyse the behaviour of companies from countries that resorted to external financial aid, specifically Greece, Italy, Ireland, Portugal and Spain (the so-called "PIIGS"). These objectives may be framed in the measurement theory, as they consider the intended effects (or not) of the recognition and measurement of impairments, in the context of a financial crisis, where the relevance of financial statements is subject to greater volatility.
A sample was analysed consisting of 1383 listed companies from 14 European countries and covering a 10-year period (2005 to 2014). In terms of methodology, logit and ordinary least squares (OLS) models were estimated to analyse the probability of recognition and the amount of impairments recognized, respectively, both for the total sample and for the two subgroups of countries: intervention and non-intervention.
The results indicate that during the financial crisis European firms recognized fewer impairments of non-financial assets, which may suggest that managers avoided recognizing impairments in order to perform better, using the discretion underlying the recognition and calculation of impairments to manage earnings upwards and thus mitigate the low performance characteristic in times of crisis.
Through the results obtained it is also possible to conclude that companies whose countries resorted to financial aid also recognized fewer impairments during the crisis period and that, unlike in the non-intervention countries, the level of enforcement of accounting and auditing standards was positively associated with the magnitude of impairments recognized.
The research findings are thus relevant both at the theoretical level and at the level of financial reporting practices. From a theoretical point of view, the evidence found allows for an understanding of the unintended effects of the measurement theory, regarding the recognition of impairments. Thus, in terms of measurement theory and the disclosure of relevant financial statements for the purpose of economic decisions, we found evidence of manager discretion that limits this relevance of financial information, especially when economic values are more volatile. We also contribute to the theoretical debate concerning the principles of measurement in the context of impairment, and how this may affect assessments of the economic values of non-financial assets. From a practical point of view, we contribute with positivist evidence that will inform regulators and investors about the economic relevance (or loss of this) of financial information on impairments, particularly in a context of greater volatility in the economy.
This study also contributes to the literature that analyses the impact of financial crises on the quality of financial reporting in general, and on the recognition of asset impairments in particular, essentially for two reasons: (1) most studies analyse the impact of the crisis on financial assets or goodwill (Carvalho, Rodrigues, & Ferreira, 2013; Glaum, Landsman, & Wyrwa, 2015; Zhang, 2011), whereas we analyse the impact on non-financial, tangible and non-tangible assets; (2) we analyse the impact of the crisis on a particular set of countries with greater financial fragility, i.e. the intervention countries. We also expect to contribute to the literature that analyses the use of asset impairment recognition in earnings management practices.
This study is divided into five sections. The second section provides a brief literature review, where we provide evidence of the main studies that support this research. In the third section the hypotheses of the study are formulated, the sample is described and the methodology adopted is presented. Section four presents and discusses the results obtained. Finally, the last section presents the main conclusions, limitations and possible suggestions for future research.
2 Literature Review
2.1 Impairment of assets and accounting information quality in the context of a financial crisis
The accounting concept of "impairment" can be defined as a reduction or loss of the recoverable value of an asset that should lead to an adjustment of its value to reflect its real economic return capacity. Companies must perform impairment tests whenever there is any internal or external event where assets may have lost economic value, with the exception of indefinite life intangible assets, which must be tested annually. Impairment losses must be recognized in the event that the book value of assets is greater than the estimated recoverable amounts. In other words, this procedure prevents assets from being overstated in the financial statements and underlies the objective of measurement theory to provide relevant information for the decision-making of the different users of financial information (Goncalves & Coelho, 2019; Larson, 1969).
However, there is evidence of some conditional conservatism in the recognition of impairments in European listed companies, this being less expressive in countries where the effectiveness of institutions and the level of disclosure is lower (Amiraslani, Iatridis, & Pope, 2013; Pinto, Gaio, & Goncales, 2019). In fact, in a study covering 235 European listed companies relating to 2011, the European Securities and Markets Authority (2013) concluded that few companies recognize goodwill impairment losses (only 36%), with recognition for other intangible assets being even more limited.
On the other hand, the fact that recognizing impairments and calculating the amount to be recognized involves value judgements and the use of estimates creates opportunities for managers to practise earnings management. There is empirical evidence that managers manage earnings by recognizing impairment losses and their respective reversals in subsequent periods (Duh, Lee, & Lin, 2009; Riedl, 2004). Earnings management through the recognition of excessive impairment losses and subsequent reversal may thus negatively affect the quality of the information reported by companies (Pinto et al., 2019).
The use of impairment recognition and its impact on accounting information quality may be even more evident in periods of financial crisis. In fact, the high volatility in financial markets and the substantial drop in company profitability and share values, which usually occur in periods of crisis, can cause losses in the economic value of assets and the need for recognition of impairment losses, with a subsequent negative impact on reported net income (Vanza et al., 2011). In periods of financial crisis, due to the increased asymmetry of information, assets tend to generate lower cash flows than expected, an effect that...
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