D. (David) Unterdorfer

RSM - Rotterdam School of Management
Erasmus University Rotterdam
ERIM Doctoral Student
Field: Finance & Accounting
Affiliated since 2014

PhD Project

On non-operating assets and their role for financial analysis

The aim of this proposal is to shed light on the role non-operating assets play for earnings forecasting, financial analysts, and investors. I attempt to show that financial assets have different properties from operating assets, and I investigate how financial analysts absorb this information. Furthermore, I investigate whether I can establish determinants of the level of investment in non-operating assets, and how financial markets value such investments. Finally, I investigate how disclosure of information on non-operating assets affects financial analysts’ forecasting.
Economists have observed an increase in financialization of American businesses since after world war 2. Financialization refers to a trend of firms replacing physical investment in, for example, PPE with financial investments, such as buying financial securities. Krippner (2005) argues that this trend has been going on since the post-world war 2 era, and has been accelerated in the 1970s by more widespread access to global financial markets. Stockhammer (2004) argues that this trend can be attributed to changing power relations between managers and shareholders, where managers adopt a stronger growth orientation at the expense of firm profitability.
This development coincides with the phenomenon of managerial capitalism, which, at its heart, has the distinction between absentee owners and well-informed, self-interested managers. Post-Keynesian economic theory predicts that, while investors are interested in high dividends and profits, management is primarily focused on amassing wealth and power, which would translate into firm growth rather than profitability (Lavoie 1992). Assuming that managers are better informed than investors, they have the upper hand in decisions regarding investment policy.
From a financial analysis perspective, this means that firms show increasingly greater levels of investments in financial assets, and diversification in areas that are not necessarily associated with their core operations. Furthermore, the implications that financializaton affects growth patterns implies an importance of investigation of this issue for valuation purposes. Whether or not this development is beneficial for overall firm performance is unclear. However, it presents challenges for financial analysts and investors, who need to unravel income streams from both operating and non-operating sources.
While researchers have established an association between financialization and firm growth and profitability, there is so far no research on how this trend relates to the analysis of financial statements. For the purpose of this PhD thesis, I have broken down the issue into three guiding questions. Firstly, how do non-operating assets, particularly financial assets, relate to a firm’s core operations and to overall firm performance, and how should we forecast firm performance in light of this trend. Secondly,
PhD Proposal July 2015 David Unterdorfer
Rotterdam School of Management 3
Department of Accounting and Control
what are the reasons for management to invest in such assets, and how does the power relation between shareholders and manager relate to such decisions. Finally, can we identify these various income streams from financial disclosure, and how does the quality of such disclosure relate to financial analysis.
The three proposed projects focus on various users of financial reports, and their interest in non-operating assets, with the intent of analysing non-operating assets from various angles. This PhD thesis introduces a distinction between non-operating and operating assets, which can find applications in, and contributes to, literature on financial analysis and valuation. Furthermore, I attempt to add to the literature on financial analysts, by investigating their use of corporate governance information. Finally, the last project adds to the disclosure literature, by investigating the disclosure of investment policies and the effect on analyst forecasts.
The first project deals with the issue of disaggregation, and investigates whether non-operating assets have different time series properties from operating assets. I argue that due to persistence differences between non-operating and operating returns, disaggregating return on business assets into these components provides valuable information for earnings forecasting. However, so far there is little empirical evidence for this distinction. While previous research has looked into various disaggregations of firm performance into its individual aspects in order to forecast future performance, such as asset turnover and profit margin as components of return on assets (Fairfield & Yohn 2001), no papers have investigated the fundamental distinction between non-operating and operating assets. It is, therefore, the goal of the first project to test whether such a disaggregation indeed provides more precise forecasts of future performance and whether the performance of non-operating assets reverts faster towards the mean than that of core operating assets. As a further test, the association between analyst forecast errors and various components of this disaggregation will be tested, in order to assess if and how these information intermediaries absorb the potentially different nature of non-operating and operating assets into their predictions.
After establishing the different properties of operating and non-operating assets, the second project investigates reasons why firms would invest in non-operating assets at all, and how investors see such investments. I investigate the power relation between management and shareholders, and argue that if management is more powerful, they would prefer to invest more cash on financial markets to further asset growth. Powerful shareholders, in turn, would prefer to see investments in core operations to provide them with sustainable abnormal profitability. The project centres in on the controlling and monitoring role of shareholders, and the reasons for firms to spend cash reserves on non-operating-, and especially financial assets. Management faces various incentives to spend cash, ranging from perquisite consumption to empire building. However, even if excess cash is spent with the intention to maximize firm value, the set of available investments might simply be small, and the options that are
PhD Proposal July 2015 David Unterdorfer
Rotterdam School of Management 4
Department of Accounting and Control
available might not be in line with the core operations of the business. Corporate governance is a system to assure an adequate return on shareholders’ invested capital, and it is reasonable to assume that large shareholders would like to channel excess cash into investments that are profitable and in line with overall firm strategy. In order to assess shareholders’ impact on investment policies, I investigate whether non-operating asset persistence differs for firms with different ownership structures as a proxy for the power relation. I expect that stronger/more concentrated ownership would translate into a smaller proportion of non-operating assets on the balance sheet. Moreover if shareholdings are concentrated, I would expect that better investments are made, which translates into stronger persistence of non-operating asset performance. Furthermore, I investigate whether such assets would also be valued more highly than assets of companies with more dispersed ownership structures. Finally, I intend to link the analysis back to the first project, by assessing whether analysts absorb information on corporate governance in their forecasts, especially in relation to non-operating asset performance.
Finally, after showing why firms choose to invest in non-operating assets and examining determinants of such investment policies, I investigate how this information is disclosed. The third projects addresses the issue of disclosure of investment policy and non-operating asset performance, and the effect on analysts’ assessment of future performance. Whether or not analysts choose to include information on non-operating asset performance in their forecasts and valuations, they first need to be able to find and understand this information. This can be achieved through either published financial reports, or voluntary disclosures. There is ample research on aspects of firms’ disclosure quality and its relation with various outcome measures (see (Healy & Palepu 2001) for an overview of the literature). However, no work addresses the question of whether a clearer or more extensive reporting policy on non-operating assets improves analyst forecasts. In this final project, I attempt to address the question whether more information on the distinction between operating and non-operating assets would indeed improve financial analysis, and to potentially shed light on the interplay between mandatory and voluntary disclosure on the topic.
The rest of this proposal is comprised of four parts. The first three outline each project individually, including availability of data and suggested approach, in varying detail. The last part is an overview of the expected timeline of completion of the projects, potential journals for publication, and suggested collaborations/research visits.

Financial Accounting, Financial Statement Analysis, Corporate Governance, Valuation
Time frame
2014 -


Visiting address

Office: Mandeville Building T08-01
Burgemeester Oudlaan 50
3062 PA Rotterdam

Postal address

Postbus 1738
3000 DR Rotterdam

Supervisory team

David Unterdorfer
Duff & Phelps Professor of Business Analysis and Valuation