Asset Write‐offs in Private Firms – The Case of German SMEs

• Date: 01 April 2013
• Published date: 01 April 2013
• Author: Aljosa Valentincic,Andrea Szczesny
• DOI: http://doi.org/10.1111/jbfa.12017

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 40(3) & (4), 285–317, April/May 2013, 0306-686X

doi: 10.1111/jbfa.12017

Asset Write-offs in Private Firms – The

Case of German SMEs

ANDREA SZCZESNY AND ALJOSA VALENTINCIC*

Abstract: This paper finds that private firms make the decision to write off, and write off more

in terms of total amount, if they are: (i) more profitable, (ii) have more financial debt, and (iii)

pay dividends. Our findings are contrary to expectations based on accounting standards and

the existing revaluation literature. They are, however, consistent with the codified, high book-

tax alignment economic setting in which sample private firms operate. This includes agency

problems faced by private firms’ stakeholders. We use a comprehensive sample of German

SMEs reporting in local GAAP, based on the German commercial code (Handelsgesetzbuch)

in 2003–2006. We view write-offs as corrections of departures of book values from their

underlying economic values, in contrast to upward asset revaluations. This governs our choice of

estimation – the tobit regression.

Keywords: asset impairment, write-offs, private firms, SME, tobit regression, agency problems,

HGB (Handelsgesetzbuch)

1. INTRODUCTION

We investigate the factors that jointly influence the probability and magnitude of

asset write-offs (or asset devaluations) in relatively large private firms. Write-offs are

conceived as a means of communicating accurate financial performance to outside

stakeholders. This setting is normally descriptive of large, publicly-quoted firms, where

write-offs are frequent and economically important. For example, Riedl (2004) reports

that in his sample of publicly-quoted firms around 16.5% of firm-year observations

write-off long-lived assets with the mean impact of 2.8% of opening total assets.

Similarly, in a survey of early write-off literature, Alciatore et al. (1998) report a

higher, but comparable, impact on financial statements of upward of 4% of total

assets.

*The first author is at the Faculty of Economics, Julius-Maximilians-University Wuerzburg, Germany. The

second author is at the Faculty of Economics, University of Ljubljana, Slovenia. This research is part of

the INTACCT programme – The European IFRS revolution (Contract No. MRTN-CT-2006-035850). The

authors wish to thank the participants at the 2009 JBFA Capital Markets conference, at the EAA 2009 and at

the AAA 2009 conference for helpful comments. The authors would especially like to thank Andrew Stark,

the Editor, for his effort to improve the original manuscript both in content and exposition. The authors

also thank Sonja Ratej Pirkovic for her advice on the methods used in this paper.(Paper received December,

2008, revised version accepted November, 2012).

Address for correspondence: Aljosa Valentincic, Faculty of Economics, University of Ljubljana, Kardeljeva

ploscad 17, 1000 Ljubljana, Slovenia.

e-mail: aljosa.valentincic@ef.uni-lj.si

C

2013 Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK

and 350 Main Street, Malden, MA 02148, USA. 285

286 SZCZESNY AND VALENTINCIC

Private firms, on the other hand, are less likely to use public financial statements to

contract with owners and lenders, and are more likely to use the financial reporting

process for tax, dividend and other policy issues (Ball and Shivakumar, 2005). Due

to cost considerations, private firms are less likely to produce two separate sets of

accounts for financial and tax purposes even if they do not operate in a codified

legal environment with high book-tax conformity (e.g., Ball et al., 2000; and Raonic

et al., 2004). Moreover, there are relatively fewer agency problems between owners and

managers (Ali et al., 2007). At the extreme, it is possible to envisage small private firms

where the owner and manager are one and the same person (Jensen and Meckling,

1976; and Ang et al., 2000). There would thus be no agency issues, nor information

asymmetries, and no need to signal the true state of the firm to (non-existing) outside

owners. On this basis, we would expect to observe relatively fewer write-offs in private

firms.

However, in an empirical setting that closely mimics this extreme situation, Garrod

et al. (2008) show that firms still write off relatively often and that write-offs have

a financial-statement impact comparable to that reported for publicly-quoted firms.

They report that 10.5% of their sample firms write off fixed assets with a mean

impact of 1.3% of opening total assets and 23.2% write off current assets with a mean

impact of 2.5%, different, but of similar magnitude, than public firms. This suggests

that the motives of private firms for writing-off assets other than reporting financial

performance are important. Existing research shows that one such motive for the

financial reporting process other than reporting firm performance is to minimize the

present value (PV) of corporate tax. With aligned incentives between owners and

managers, minimization of the PV of corporate tax represents a rational (personal)

value-maximizing decision by managers as opposed to an opportunistic decision by

the managers at the expense of the owners (Fields et al., 2001).

As one moves from this “restricted” private firm setting towards large, public

corporations, ownership becomes more dispersed, information asymmetries increase,

agency issues may arise, firm financing becomes more complex and paying out

dividends becomes important. Hence, using financial statements to communicate the

financial performance of the firm is likely to be more important than it is in small

(-er), closely-held private firms, but less important than in large, publicly-quoted firms.

Equally, motives other than minimizing the PV of corporate tax enter the financial

reporting process and influence the accounting choices firms make in this process.

We identify two such motives: (i) the creation of “reserves” for future compliance with

debt covenants requirements, and (ii) the ability to pay out dividends if owners require

such a type of transfer of wealth.

The empirical setting we use in this paper – the German small and medium

enterprises (SMEs) – reflects this “intermediate” agency situation. In addition to the

issue of ownership complexity, the firms in our sample are characterized by: (i) their

access to debt financing which represents a non-trivial source of financing, and (ii)

the potential importance of dividends to those shareholders that have no access to

internal information. In this study, 51.8% of firms have access to outside financial

debt with the median debt-to-asset ratio of 23.7%. This is a far larger percentage of

firms and a far higher debt-to-asset ratio compared to studies for small private firms.

For example, Garrod et al. (2007) and Garrod et al. (2008) both show that close to

75% of small private firms in their sample do not have access to financial debt and,

even when they do, the relative amounts of financial debt are small, i.e., financial

C

2013 Blackwell Publishing Ltd

ASSET WRITE-OFFS IN PRIVATEFIRMS – THE CASE OF GERMAN SMEs 287

debt is not an important source of finance overall. Similar numbers for private firms

are reported in Kosi and Valentincic (forthcoming). What our data reflect is that the

SMEs in Germany traditionally rely almost exclusively on bank credit as a source of

external debt financing. For our sample period the German Savings Banks Association

(Deutscher Sparkassen und Giroverband, DSGV) documents payables to banks expressed

as a percentage of total assets at about 36% (DSGV, 2010 and 2011). We know very

little of dividend payouts in private firms in general and existing studies of write-offs in

private firms do not have access to dividend payout data. In our sample, 5.8% of firms

pay dividends with a median payout ratio of 75.1% (mean 54.5%). Thus, in addition

to exploring the influence of the agency issue in the relationship between owners and

managers on accounting choice as reflected through asset write-offs, the issue of using

accounting discretion to achieve debt and dividend “targets” represents an addition

to existing literature on private firms. To our knowledge, there are no studies that

address the issue of write-offs and its consequences in such a setting and, thus, we fill

an important gap in the existing literature.

The German SME setting has at least three additional advantages. First, write-offs

are a relatively rare occurrence in our sample (only 1.6% of firms write off fixed assets,

2.8% current assets, and 4.4% either fixed or current assets). This is consistent with

high levels of unconditional conservatism in German financial statements (Gassen

et al., 2006). Assets on the balance sheet are on average undervalued due to the

historical cost concept and planned depreciation of assets over short useful lives of

the assets and they contain hidden reserves. This places a limit on the extent to

which ex-post conservatism can be practised (Pope and Walker, 2003), of which write-

offs are a manifestation. This suggests that write-offs appear in financial statements

“conservatively”, i.e., only when the underlying economic motive, either operational

or discretionary, is very strong. More generally, any tax, debt or dividend motives to

report lower income as a result of a write-off are weighed against: (i) tax costs of

reporting lower income (i.e., increasing likelihood of a tax audit; Garrod et al., 2007);

(ii) non-tax costs (e.g., possible decrease of managerial compensation, negative capital

market effects; Cloyd et al., 1996); and (iii) other non-tax benefits (e.g., employees are

less likely to demand higher wages if reported income is low; Brown et al., 1992).

The existence of these costs and benefits also implies that extracting benefits related

to the elements in this study is not straightforward and helps to explain the relative

rare occurrence of write-offs in our sample. Nevertheless, their economic impact on

the financial statements is comparable to those reported for both public and private

firms. The second advantage is that a recent survey of small and medium-sized firms in

Germany (Eierle et al., 2007) asks SMEs about the importance of different purposes of

financial accounting. The vast majority of the respondents (86%) name tax purposes as

highly important. Almost the same (63%) holds for the purpose of the determination

of the level of dividends. Information purposes for potential investors are, in contrast,

ranked as not or only slightly important by 81% of the respondents (Eierle et al., 2007).

Third, this survey also shows that there is a strong de facto correspondence between

reporting for financial and tax purposes: 79% of the 410 respondents indicate that

they prepare only one set of accounts for financial and tax purposes (Eierle et al.,

2007).

Using write-offs as one specific type of accrual to capture the effects of reporting

incentives on accounting discretion enhances the power of our empirical tests (Beatty

et al., 2002; and McNichols, 2002) as it allows us to better formulate expectations about

C

2013 Blackwell Publishing Ltd