Conditional Earnings Conservatism and Corporate Refocusing Activities

We extend standard models of conditional earnings conservatism and adaptation value to the context of the corporate refocusing activities of UK listed companies. This analysis is interesting because refocusing activities are: (1) commonly anticipated by significant negative returns in the financial year(s) before the refocusing event; (2) typically associated with large material charges; and (3) likely to be part of a strategic plan with the internal decision preceding the formal public announcement. We complement Burgstahler and Dichev [1997] by showing how their nonlinear relation between share prices and earnings changes around refocusing events as adaptation options are exercised. Because refocusing events also involve large realized losses and major changes to firms’ strategic plans, we expect to see systematic changes in the timing relations between stock returns and reported earnings. To capture this, we show how the coefficients of Basu's [1997] model of conditional conservatism change around refocusing events.