How Diversification, Acquisitions and R&D Influence Decisions to Discontinue Operation

• In Event: Financial Accounting and Reporting 2

Abstract

Reports of discontinued operations have received little attention in accounting research. However, recently regulators have revised the definition, emphasizing that this item should relay information about strategic shifts that have major effects on an entity’s operations and financial results.
We employ logistic regression to analyze reporting of discontinued operations to better understand the strategy behind disposals. We test four hypotheses about operating factors that influence firms’ choices. First, the Corporate Focus Hypothesis suggests that over-diversification is a compelling reason to divest non-core assets. Second, we examine whether or not managers of firms that discontinue an operation, are already sharpening corporate focus. Finally, we consider whether growth is financed through internal R&D or external acquisition effects divestitures.
We show that firms that discontinue operations are more widely diversified than the control sample. The majority have already begun to decrease the scope of their diversification. But, diversity has been increasing for a sizeable number. Those that divest a unit are more likely to have made acquisitions in the past. The enterprises that announce positive-valued discontinued operations make greater expenditures on R&D, while those that divest negative-valued units are less research-active.
Among the firms that divest an operation, undiversified entities are most likely to discontinue units with negative values. Clearly, firms that have been decreasing diversification are more liable to have divested units, especially with positive values. They are also likely to be active in R&D, and to make external acquisitions. Sensibly, firms that have been increasing diversification are more liable to have made acquisitions and less likely to have divested a unit. But, there is a high probability that they will discontinue more operations in the following years.
Firms that are involved in R&D are more likely to discontinue positive-valued operations, suggesting that these divestitures are intended to provide positive signals about intangible assets to markets. Research-active firms that discontinue operations tend to have very wide corporate diversification, but this level of diversity has usually been declining in recent years. These divestitures are typically isolated incidents.
Firms that make external acquisitions are less diversified than those that do not, but their diversity is increasing. Their announcements of discontinued operations tend to be part of an on-going series of divestitures, which also usually continues into the future. These findings provide a clear indication that acquisitions and divestitures go on hand-in-hand, and that firms often use external acquisitions to obtain specific, targeted knowledge.

Authors

• Yoshie Saito, Old Dominion University

• Richard Lord, Montclair State University