Does reporting position affect the pricing of the volatility of comprehensive income?

The FASB changed the reporting policy for comprehensive income (CI) by issuing ASU No. 2011-05, which requires CI be reported in performance statements (i.e., either a single income statement with net income or a separate statement of CI following the income statement) rather than the previously allowed equity statements. We examine whether the change in reporting position of CI led to higher market pricing of CI volatility incremental to NI volatility (“incremental CI volatility”), as measured by the price-earnings relationship. We find that the market pricing of incremental CI volatility increased from the pre- to the post-ASU period for non-financial firms forced to change the reporting position of CI from equity to performance statements. The increase is more prominent for firms that switched to the income statement than for firms that switched to a separate statement of CI. Further, we find that the increased market pricing of incremental CI volatility translates into lower valuation weights on other comprehensive income.     

Usefulness of fair values for predicting banks’ future earnings: evidence from other comprehensive income and its components

This paper examines whether fair value adjustments included in other comprehensive income (OCI) predict future bank performance. It also examines whether the reliability of these estimates affects their predictive value. Using a sample of bank holding companies, we find that fair value adjustments included in OCI can predict earnings both 1 and 2 years ahead. However, not all fair value-related unrealized gains and losses included in OCI have similar implications. While net unrealized gains and losses on available-for-sale securities are positively associated with future earnings, net unrealized gains and losses on derivative contracts classified as cash flow hedges are negatively associated with future earnings. We also find that reliable measurement of fair values enhances predictive value. Finally, we show that fair value adjustments recorded in OCI during the 2007–2009 financial crisis predicted future profitability, contradicting criticism that fair value accounting forced banks to record excessive downward adjustments.     

Preserving amortized costs within a fair-value-accounting framework: reclassification of gains and losses on available-for-sale securities upon realization

SFAS No. 115 requires firms to recognize available-for-sale (AFS) securities at fair value with accumulated unrealized gains and losses (AUGL) recorded in accumulated other comprehensive income. Firms reclassify AUGL to net income when they realize gains and losses. We refer to the amount reclassified each period by “RECLASS.” As of 1998, SFAS No. 130 requires firms to present RECLASS prominently in their financial statements. We investigate the incremental explanatory power of RECLASS for banks’ market values and market-adjusted returns. In the market value analysis, we control for AUGL, other components of book value of equity, net income before extraordinary items and RECLASS (NIBEX^other), and other components of comprehensive income. In the returns analysis, we control for ΔAUGL, ΔNIBEX^other, and extraordinary items. We find high positive coefficients on RECLASS in both analyses, consistent with investors pricing RECLASS as a relatively permanent component of net income. Exploring possible explanations for these pricing implications, we find no evidence that they are attributable to RECLASS remedying unreliable fair value measurement of AUGL. We provide three distinct analyses indicating that RECLASS’s pricing implications are explained in significant part by it helping investors predict banks’ future performance. Our results illustrate that an important type of amortized cost accounting information, realized gains and losses, remains highly useful to investors despite the overall fair-value-accounting framework for AFS securities.     

The Sale of Assets to Manage Earnings in Japan

In this article we investigate Japanese managers' use of income from the sale of fixed assets and marketable securities to manage earnings. The earnings management target examined is Japanese managers' forecasts of current–year earnings. We find a negative relation between income from asset sales and management forecast error. When current reported operating income is below (above) management's forecast of operating income, firms increase (decrease) earnings through the sale of fixed assets and marketable securities. The results hold after controlling for expected future performance, debt–to–equity ratio, size, growth, and last year's income from asset sales.     

Bank earnings and regulatory capital management using available for sale securities

Based on a large sample of publicly listed and non-listed US commercial banks from 1996 to 2011, we find robust evidence consistent with banks using realized available for sale (AFS) securities gains and losses to smooth earnings and increase low regulatory capital. We also find that (i) banks with positive earnings smooth earnings, and banks with negative earnings generally take big baths; (ii) regulatory capital constrains big baths; (iii) banks with more negative earnings and more unrealized beginning-of-quarter losses (gains) take big baths (smooth earnings); and (iv) banks with low regulatory capital and more unrealized gains realize more gains. Also, banks with negative earnings take big baths (avoid or reduce the earnings loss) if their unrealized gains are insufficient (sufficient) to offset the negative earnings. Our inferences apply to listed and non-listed banks, which indicates that the earnings management incentives do not derive solely from public capital markets. Our findings reveal that the accounting for AFS securities gains and losses enables banks to manage regulatory capital and earnings in a variety of ways.     

Why Do Analysts use a Zero Forecast for Other Comprehensive Income?

Accounting theory and accounting researchers stress the importance of clean surplus accounting and comprehensive income to corporate valuation. However, casual observation suggests that sell-side equity analysts routinely ignore other comprehensive income (OCI) in their forecasts and instead focus on forecasting earnings (before OCI). Using a sample of analyst reports, I first confirm that analysts normally omit forecasts of OCI or comprehensive income from their reports, consistent with analysts forecasting OCI as zero. I then predict and find that a zero forecast for OCI generally produces lower forecasting errors than alternative time-series models, such as a random walk or AR(1) model, suggesting a rational reason why analysts take this approach. Finally, I predict and find that although analysts’ point forecasts of future OCI are usually zero, their implied cost of equity estimates are consistent with analysts forecasting a positive variance for OCI.     

Using Available-for-sale Securities to Smooth Earnings: Evidence from China

Utilizing a large sample of non-financial public firms in China from 2009 to 2016, we find robust evidence that non-financial firms smooth their earnings through realized gains and losses on available-for-sale (AFS) securities. This effect is more pronounced for firms with weaker internal and external corporate governance. Firms with an incentive to manipulate up their earnings are also less likely to smooth earnings through AFS securities. Moreover, firms with more accrual earnings management or real earnings management tend to smooth earnings to a greater extent through AFS securities. Firms smooth earnings only when their net income is positive or when net income is negative and the gains from AFS securities are large enough to offset negative earnings. We do not find supporting evidence for engaging in big bath earnings management through the realization of losses on AFS securities. These findings suggest that gains and losses on AFS securities allow non-financial firms to actively smooth their earnings. Last, the accounting standards amendments in 2017 that essentially disable earnings smoothing through AFS securities increase price efficiency.     

Value Relevance of Comprehensive Income for the Canadian Market*

The value relevance of comprehensive income (CI) compared to net income (NI) remains unresolved. We look at this issue in the Canadian market, using association methods to determine the value relevance of reporting CI and other comprehensive income (OCI) components for stock prices and returns. The sample consists of all the firms in the S&P/TSX Composite Index that prepared their financial statements according to Canadian standards or International Financial Reporting Standards (IFRS) over the 2008–2016 period. Although we find no evidence that CI is more value relevant than NI for stock prices and returns, we note that some OCI components are incrementally value relevant beyond NI for both amounts. In addition, financial services firms differ from other companies in terms of the relationships between some of their OCI components and prices or returns, with such firms even driving some relationships. Relationships between OCI components and prices or returns are also affected when data from the financial crisis period are excluded, with some relationships even changing after IFRS adoption. These results inform Canadian standard setters and financial statement users that OCI components are decision useful for the Canadian market.     

An evaluation of SFAS No. 130 comprehensive income disclosures

In this study, we provide evidence on the pricing of other comprehensive income (OCI) that differs from most evidence in prior research. Prior archival research has largely concluded that OCI is not priced by investors. In contrast, we provide evidence in the post-SFAS 130 period that OCI is priced on a dollar-for-dollar basis as is predicted by economic theory for transitory income items. We attribute this finding to our use of post-SFAS 130 as-reported measures of OCI rather than pre-SFAS 130 as-if estimates of OCI measures. Furthermore, we document that two components of OCI, foreign currency translation adjustment and unrealized gains/losses on available-for-sale securities, are priced by investors. In the post-SFAS 130 period, we also find that the type of financial statement in which firms report OCI and its components affects pricing, consistent with the conclusions of prior experimental research. However, our evidence suggests that investors pay greater attention to OCI information reported in the statement of changes in equity, rather than in a statement of financial performance. This could be attributed to investors becoming more familiar in the post-SFAS 130 period with the predominant reporting of OCI and its components in the statement of changes in equity. These findings may be relevant to both the Financial Accounting Standards Board and the International Accounting Standards Board, which jointly are undertaking a new project that, in part, is addressing financial statement presentation of OCI items.

Does the Reporting Location of Other Comprehensive Income Matter? The Investor's Perspective

In the context of changes mandated by the Chinese Ministry of Finance in January 2009 regarding the location in which other comprehensive income (OCI) is reported, this paper finds that reporting OCI on the performance statement significantly improves its value relevance. The improvement is driven by two OCI items: unrealised holding gains/losses on available‐for‐sale securities and the share of other comprehensive income of investees under the equity method. Our results show that the OCI reporting location matters, which supports the psychological perspective that investors pay more attention to salient information. Our findings lend strong support to the approach of standard setters in reporting OCI on the performance statement.     

现代公司预算编制起点问题的探讨──兼论公司财务报告的改进

本文在界定以生产为起点和以销售为起点的两种传统预算编制方法所适用的条件的同时，论证了以所有 权与管理权相分离为特征的现代公司应以每股收益或利润为起点编制预算的观点。在实务上按照这种现点编制 预算，不仅有助于提升所有者和经营者对整个公司计划和控制的能力，顺势通过改善经营管理来影响本公司股 价，而且还为财务报告的改进提供了新的线索。由于预算编制结果也可用资产负债表、利润表和现金流量表来 表述，本文建议将按每股收益为起点编制的预算以及定期甚至实时编制的预算反馈报告进行公开披露，以增强 现行财务报告的前瞻性、及时性和明细化程度，为投资者提供更加有用的信息。     

Mixing fair-value and historical-cost accounting: predictable other-comprehensive-income and mispricing of bank stocks

Other comprehensive income (OCI) items are often considered to be transitory (Chambers et al. 2007; IASB 2013; CFA2014). In this paper, we show that a significant portion of OCI, namely unrealized gains and losses (UGL) from available-for-sale (AFS) debt securities, is non-transitory: a negative correlation between accumulated unrealized gains and losses in the current period and next period UGL is predicted, and we show that this correlation is economically and statistically significant. This correlation is due to a mix of accounting methods of measurement of income from fixed-income securities: UGL are recognized based on fair values, whereas interest income is measured based on historical cost. We document that (1) this negative correlation helps explain a previously unexplained negative correlation in other comprehensive income (OCI), and (2) investors seem to price total UGL disregarding (or not understanding) the predictable, accounting-driven component of UGL.     

From compromise to concept? – a review of ‘other comprehensive income’

This paper reviews how ‘other comprehensive income’ (OCI) entered financial reporting by tracing major Financial Accounting Standard Board (FASB) and International Accounting Standards Board (IASB) projects that required direct entries to equity and describing recent efforts to make sense of the practice. It was the fixation on net income that brought about departures from all-inclusive income, which were repeatedly made over the years without decidedly devoting attention to developing a conceptual basis. OCI was used as a compromise to incorporate current values in the balance sheet, while retaining historical cost principles in the income statement. When the practice was labeled as OCI, it became institutionalized without a clear meaning. A sense-making of the practice then replaced the debates on the adequacy of using OCI and standard setters have realized that additional layers of theory became necessary to explain, for example, reclassification adjustments. Yet, the IASB has made clear in its recent Exposure Draft of a revised conceptual framework that it does not intend to pursue a fresh start in performance reporting that appears to be needed conceptually. Instead, practical considerations, primarily on International Financial Reporting Standards adoption in Japan, seem to lead to another ex-post rationalization of OCI, this time around a conceptually vacuous use of the relevance characteristic.     

新会计准则中合并报表理论变革的经济后果研究——基于少数股东权益、少数股东损益信息含量变化的研究

本文研究新会计准则在合并财务报表方面的变迁对少数股东权益和损益信息含量的影响。2006年2月15日颁布并于2007年实施的"新合并财务报表准则"(企业会计准则第33号——合并财务报表)相对旧准则做出了修改:规定少数股东权益在合并资产负债表所有者权益项目下单独列示;少数股东损益在合并利润表中净利润项目下单独列示。本文发现,新会计准下,少数股东权益的价值相关性显著提高,且显著高于净资产其他组成部分的价值相关性提高程度;少数股东损益信息含量显著增加,且增加量显著高于盈余的其他组成部分带来的信息增加量。本文的经验证据支持了新会计准则中合并财务报表的实体理论,研究结论说明,新会计准则的实施使得合并财务报表具有更多信息含量。     

Implied Equity Duration: A New Measure of Equity Risk

Duration is an important and well-established risk characteristic for fixed income securities. We use recent developments in financial statement analysis research to construct a measure of duration for equity securities. We find that the standard empirical predictions and results for fixed income securities extend to equity securities. We show that stock price volatility and stock beta are both positively correlated with equity duration. Moreover, estimates of common shocks to expected equity returns extracted using our measure of equity duration capture a strong common factor in stock returns. Additional analysis shows that the book-to-market ratio provides a crude measure of equity duration and that our more refined measure of equity duration subsumes the Fama and French (1993) book-to-market factor in stock returns. Our research shows how structured financial statement analysis can be used to construct superior measures of equity security risk.     

其他综合收益、分析师预测与决策价值

其他综合收益作为“脏盈余”的回收站,是否对信息使用者具有决策价值是困扰准则制定者的重要学术问题,从资本市场最专业的财务报表使用者——证券分析师视角出发,研究其他综合收益对分析师盈余预测的影响,检验分析师是否能够有效识别利用其他综合收益信息.研究结果表明:其他综合收益信息对分析师盈余预测准确性有显著影响,即其他综合收益比重高的企业,分析师盈余误差的分歧越大;其他综合收益强制披露后分析师解读成本减低,盈余预测准确性得以提高.结论支持现阶段其他综合收益信息在分析师利预测中的作用,间接证明其他综合收益的决策价值.     

Management earnings forecast and financial statement complexity

We investigate the manager’s earnings forecasting strategy when financial statement complexity becomes a significant issue in capital markets. We suppose that complexity in financial statements arises from complexity of firm’s business transactions (business complexity) or complexity of associated reporting standards (reporting complexity) as mentioned in Guay et al. (2016). We find that a manager’s forecasting strategy depends on whether financial statement complexity stems from business or reporting complexity. Specifically, we indicate, among other observations, that managers who initially announced optimistic earnings forecasts will revise and release pessimistic earnings forecasts when financial statement complexity stems from reporting complexity.     

Do Publicly Signalled Earnings Management Incentives Affect Analyst Forecast Accuracy?

Using a panel of listed Australian firms for the years 1999–2007, this paper investigates whether analysts' forecast efficiency is improved by the occurrence of a publicly observable event, such as a CEO appointment, which signals a firm's earnings management incentives. Two supporting hypotheses are also tested: first, that CEO appointments are associated with income‐decreasing earnings management; and second, that analyst forecast errors increase with the level of earnings management present in current period financial statements. Consistent with prior literature, we find income‐decreasing earnings management in the year of CEO appointment. Earnings management, as a general phenomenon, is found to be significantly related to analyst forecast errors in the period in which the earnings management occurs. However, we present evidence that analyst forecasts for current year earnings are significantly more accurate with respect to earnings management in cases where a CEO is appointed during the current financial period.     

Subjectivity in fair-value estimates,audit quality,and informativeness of other comprehensive income

This study empirically examines whether difference in audit quality is reflected in the pricing of other comprehensive income (OCI). Specifically, we first investigate whether OCI measures of Big 4 clients are more value-relevant than those of non-Big 4 clients. Considering different degrees of subjective management judgment involved in the OCI reporting process, we then explore whether the differential valuation effect of OCI between Big 4 and non-Big 4 clients is more pronounced for more subjective OCI components (e.g., minimum pension liability and foreign currency-translation adjustment) than a less subjective component (e.g., marketable securities adjustment). We predict that the aggregate OCI of a Big 4 client is more value-relevant than that of a non-Big 4 client. We also hypothesize that the differential valuation effect between Big 4 and non-Big 4 clients can be attributed to the amount of subjective assumption and judgment required in estimating OCI. Consistent with our predictions, we find that aggregate OCI audited by a Big 4 auditor has incremental information content over earnings, compared to OCI audited by a non-Big 4 auditor. More interestingly, our results also show that the differential valuation effect between Big 4 and non-Big 4 clients is stronger for OCI components of a more subjective nature. Our results are robust even after controlling for self-selection bias, the potential effect of the financial crisis, and other related effects.     

The implied cost of equity capital,corporate investment and chief executive officer turnover

This study investigates how the cost of equity capital, along with corporate investment, affects chief executive officer (CEO) turnover decisions. We hypothesize that the cost of equity conveys information about firm performance uncertainty that is informative of CEO talent. Consistently, our empirical results show that the likelihood of CEO turnover is positively associated with the implied cost of equity, after controlling for earnings and stock performance measures and risk factors. Additional analysis of reverse causality supports the causal effect of the high cost of equity on CEO dismissals. We also find that the positive association is more pronounced for firms that are more likely to suffer from underinvestment problems. These results suggest that the cost of equity plays a more important role in assessing CEO performance when the firm needs more external equity capital to pursue investment opportunities.