Accounting comparability and the value relevance of earnings and book value

• Author: Ahmet C. Kurt,Irene Guannan Wang,Bingyi Chen
• DOI: http://doi.org/10.1002/jcaf.22459
• Date: 01 October 2020
• Published date: 01 October 2020

BLIND PEER REVIEW

Accounting comparability and the value relevance

of earnings and book value

Bingyi Chen

1

| Ahmet C. Kurt

2

| Irene Guannan Wang

1

1

Department of Accounting, Sawyer

Business School, Suffolk University,

Boston, Massachusetts

2

Department of Accounting, Bentley

University, Waltham, Massachusetts

Correspondence

Irene Guannan Wang, Sawyer Business

School, Suffolk University, Boston, MA

02108.

Email: igwang@suffolk.edu

Abstract

The value relevance of financial statements is of great significance to investors

and standard setters. The present research examines whether account-

ingcomparabilityamongindustrypeers enhances the value relevance

of earnings and book value. This is an important question because both

the Financial Accounting Standards Board and the Securities Exchange

Commission seek greater comparability in financial reporting. How-

ever, there is limited empirical evidence on how comparability affects

the value relevance of accounting information in the United States.

Our results show that accounting comparability increases the value rel-

evance of earnings, but not book value. That is, when firms exhibit

greater accounting comparability vis-à-vis industry peers, investors

attach higher value to reported earnings. In terms of economic signifi-

cance, the value relevance of earningsis25.2%higherwhenaccounting

comparability is higher by one standard deviation. However, the incre-

mental benefits of accounting comparability are attenuated when

financial reporting opacity is high or when there exists an internal

control material weakness over financial reporting. In contrast,

comparability benefits are enhanced when an industry specialist audi-

tor is employed. Our results are robust to using different model

specifications.

KEYWORDS

accounting comparability, financial reporting opacity, internal controls, specialist auditors, value

relevance

JEL CLASSIFICATION

G14; M41

The FASB makes accounting standards work

so investors can be assured that the informa-

tion that companies provide is relevant, com-

parable, verifiable, and understandable.

(Financial Accounting Standards Board [FASB], 2018)

1|INTRODUCTION

Accounting comparability is one of the enhancing

characteristics of a financial reporting system. It is defined

broadly as the extent to which two reporting entities facing

the same economic events use similar accounting methods

Received: 19 November 2019 Revised: 2 June 2020 Accepted: 8 June 2020

DOI: 10.1002/jcaf.22459

82 © 2020 Wiley Periodicals LLC J Corp Acct Fin. 2020;31:82–98.wileyonlinelibrary.com/journal/jcaf

to record the underlying transactions (e.g., De Franco,

Kothari, & Verdi, 2011; henceforth DKV).

1

When describ-

ing comparability, FASB (2010, p. 19) stresses: “informa-

tion about a reporting entity is more useful if it can be

compared with similar information about other entities.”

In fact, an emerging stream of literature has documented

several benefits of accounting comparability. For example,

greater comparability is associated with lower information

asymmetry (Peterson et al., 2015), a stronger link between

current stock ret urns and future firm performance (Cho i,

Choi, Myers, & Ziebart, 2019), better analyst forecast per-

formance (De Franco et al., 2011), and more efficient cor-

porate financing decisions (Chen, Collins, Kravet, &

Mergenthaler, 2018). Despite the growing evidence on the

benefits of accounting comparability, there is limited

understanding of comparability's role in investors' valua-

tion decisions and its interaction with other financial

reporting characteristics (e.g., reporting opacity and exter-

nal auditing). The present research aims to fill this void in

the literature.

Our study focuses specifically on the moderating

effect of comparability on how well accounting amounts

reflect information used by equity investors, that is, the

value relevance of accounting information (Barth, Bea-

ver, & Landsman, 2001). Relevant accounting informa-

tion enables investors to make informed trading

decisions and thereby is incorporated into stock prices.

Nevertheless, the usefulness of accounting information

for investors depends critically on the extent to which

information can be benchmarked across peer firms. The

accounting standard setters maintain that comparability

enhances the relevance of accounting information and

facilitates investors' assessment of alternative investment

opportunities (FASB, 2010). In our research, we define

peer firms as all other firms operating in the same two-

digit Standard Industry Classification (SIC) industry of

the focal firm (e.g., De Franco et al., 2011; Peterson

et al., 2015).

We argue that, because accounting comparability

increases both the quantity and quality of financial infor-

mation available to investors, it improves the value rele-

vance of the key financial metrics examined in previous

literature—earnings and book value of equity (e.g., Bae &

Jeong, 2007; Burgstahler & Dichev, 1997; Chiang,

Kleinman, & Lee, 2017; Clarkson, Hanna, Richardson, &

Thompson, 2011). Our examination focuses on account-

ing comparability for the following three reasons.

First, extant research suggests that greater compara-

bility enriches the information environment of a focal

firm by facilitating benchmarking and providing inves-

tors with access to a larger body of the industry- and

market-level information (De Franco et al., 2011; Fang,

Iselin, & Zhang, 2019). That is, the increase in the supply

of information from comparable firms' results in an

enriched information environment overall and makes the

financial statements of a focal firm more informative for

the capital market participants (Choi et al., 2019).

Second, comparability boosts the quality of the infor-

mation provided in the financial statements. Previous

studies have found that comparability improves the preci-

sion of financial information, making it easier for the

market participants to assess the fairness of reported

financial statements in light of peer information and

reducing the uncertainty in their valuation decisions

(e.g., Peterson et al., 2015). Comparability also improves

information quality by constraining managers' ability to

hide bad news from investors (Kim, Li, Lu, & Yu, 2016).

Third, accounting comparability lowers the cost of

gathering and processing firm-specific information

(e.g., Bradshaw, Miller, & Serafeim, 2009; Choi

et al., 2019; De Franco et al., 2011; Kim, Kraft, &

Ryan, 2013). Unlike market-wide information, firm-

specific information is costly to gather and process due to

limited resources on the part of investors. Comparability

has been shown to help relatively less-informed investors

better understand firm-specific information (Choi

et al., 2019) and perform financial analysis with standard-

ized metrics (Kim et al., 2013). Because comparability

reduces investors' information gathering and processing

costs, it allows for a more precise and effective valuation

of financial information.

For our empirical analysis, we use OLS multiple

regression model with accounting comparability as the

moderating variable. Specifically, using a large sample of

U.S firms for the period 1996–2015, we regress firms'

stock prices on earnings (i.e., net income per share), book

value (i.e., book value of equity per share), two-way inter-

actions of both variables with accounting comparability,

and year and industry dummies.

2

We employ De Franco

et al.'s (2011) accounting comparability measure, which

conceptually captures the similarity of peer firms'

accounting systems in mapping a given set of economic

events onto financial statements.

We predict that the relation of stock price with earn-

ings and book value is positively moderated by account-

ing comparability. As expected, our results show that

accounting comparability improves the value relevance

of earnings. The documented effect is economically

meaningful. When accounting comparability is one stan-

dard deviation above the mean, the value relevance of

earnings is higher by 25.2%. However, we find no evi-

dence that accounting comparability has a significant

moderating effect on the value relevance of book value.

We rationalize this finding as follows. Although both

earnings and book value are valued positively by inves-

tors, these metrics have different economic implications.

CHEN ET AL.83