Consistency as a Path to Comparability: Benefits and Costs

• In Event: Earnings Comparability

Abstract

This paper analyzes the benefits and costs of consistency-based financial statement comparability. Modeling comparability as firms' required propensity to adopt common accounting methods, we show that it creates information spillover among firms through correlated accounting measurements ("spillover informativeness") while reducing firms' own reporting precision ("standalone informativeness"). The model generates two testable predictions. First, firms' fundamental correlation diminishes the information gains via spillover informativeness. Second, fundamental volatility exacerbates the information losses via standalone informativeness. To test these predictions, we use the measure of De Franco, Kothari, and Verdi (2011), which strictly increases with our defined comparability, and examine its effect on implied volatility at quarterly earnings announcements. In support of the model, comparability's net information benefits decrease when firms' stock returns are highly correlated and/or volatile. These results are robust to using financial crises and industry merger waves as instrumental variables for fundamental correlation and fundamental volatility, respectively. Overall, this paper provides a framework for studying comparability and highlights the offsetting effects of comparability on earnings informativeness.

Authors

• Michael Iselin, University of Minnesota-Minneapolis

• Gaoqing Zhang, University of Minnesota-Minneapolis

• Vivian Fang, University of Minnesota