This study investigates the managerial incentives to use discounted cash flows in downward asset revaluations, within an agency cost framework. Specifically, the study hypothesises that firms downwardly revaluing assets using discounted cash flows are taking a 'bath'. However, this managerial incentive will be constrained by the firms explicit and implicit contracts already in place. The contracts examined include debt constraints and financial slack constraints, which have been investigated with regard to upward revaluations by previous research, as well as the level of revenue reserves.
There was no evidence found in the study to support the proposition that revaluing firms were taking a 'bath'. Further, no persuasive evidence was found to suggest that debt contracts will constrain the revaluation decision. However, some significant support was found for the proposition that revaluers had higher levels of revenue reserves. Contrary to expectations, a significant association suggesting that revaluing firms had lower levels of financial slack was found.
The results of an additional test found that the valuation technique is associated with the choice of auditor. Therefore, the adoption of discounted cash flow analysis does not appear to be costly.