The Value Relevance of Multiple Occurrences of Nonrecurring Items

Abstract

Discontinued operations, special items, or extraordinary items typically are nonrecurring items in firms' income statements. As such, prior research has theorized that these items are of minimal relevance to market valuation of the firm, since they are transitory in nature. Moreover, anecdotal evidence in the financial press is supportive of this notion. We examine firms that report either single or multiple occurrences of such items over a rolling six-year period between 1977 and 1996 and find in both cases that such items are value-relevant. When multiple occurrences are not partitioned by type (discontinued operations, special items, or extraordinary items), the more recent such event in the series has a negative effect upon market value of equity, whether it has had a positive or negative effect upon net income.

This is consistent with at least two possible explanations, multiple occurrences of such items indicate firms in financial difficulty, or multiple occurrences indicate firms whose managers have engaged in repeated attempts at earnings management, and that the most recent attempt is being devalued by the market. We find patterns of discretionary accruals consistent with managers engaging in upward earnings management prior to multiple write-downs using special items. We also find that firms with multiple write-downs are more likely to go into liquidation or bankruptcy within the next five years. We find that single occurrences also are value-relevant and are positively correlated with market values. Tests on the sample when partitioned by type lead to similar results, though signs of the effects upon net income change in some instances.