CHARACTERISTICS AND SUBSEQUENT OPERATING PERFORMANCE OF FIRMS ELECTING QUASI-REORGANIZATIONS

Abstract

A quasi-reorganization is an accounting transaction that permits a firm with a retained earnings deficit to transfer that deficit to paid-in capital in conjunction with a restatement of its assets and liabilities to current market values. In this paper, we provide empirical evidence on the characteristics and subsequent operating performance of a sample of firms that elected quasi-reorganizations in the 1978-1991 time period. We find that, on average, the quasi-reorganization firms were larger than a sample of firms that were eligible, but chose not to, elect a quasi-reorganization. After controlling for size differences, we demonstrate that the quasi-reorganization sample firms had a higher debt-to-assets ratio, a larger retained earnings deficit, and were more likely to declare bankruptcy or liquidate in the three years subsequent to the quasi-reorganization than the control sample.

In addition, we are unable to support the hypotheses that firms elect quasi-reorganizations to

allow them to pay dividends or to issue new debt or equity securities. Finally, we demonstrate extremely limited subsequent operating performance differences in the quasi-reorganization firms and a group of negative retained earnings firms that elected not to undertake a quasi-reorganization. Therefore, our results do not lend support to the alleged usefulness of the quasi-reorganization procedure as a way to allow “fresh start” accounting for firms that have indeed “turned the corner” in terms of profitability. Based on our results, we recommend that the Financial Accounting Standards Board reconsider whether the quasi-reorganization procedure should remain a component of generally accepted accounting procedures.