A Test of the Abandonment Hypothesis Using Voluntarily Liquidating Firms and Unprofitable Surviving Firms

Abstract

This study tests the abandonment hypothesis utilizing a sample of poorly performing companies that do not liquidate, and a sample of strongly performing companies that liquidate voluntarily. This research design, where the liquidation (or nonliquidation) event disagrees with firms' earnings histories, eliminates certain confounding effects and tests the abandonment option hypothesis in contexts not previously studied.

For the poorly performing surviving concerns, we find that book value increases and earnings decreases in valuation significance as the number of consecutive losses increases. As predicted by the abandonment hypothesis, a sufficiently weak earnings history increases the reliance on book value even though bankruptcy or liquidation is not imminent.

For the voluntarily liquidating group, book value increases and earnings decreases in valuation significance in the years immediately preceding liquidation. This suggests that, even in the absence of financial distress, the reliance on book value increases as abandonment becomes imminent.