Accounting comparability and the value relevance of earnings and book value

AuthorAhmet C. Kurt,Irene Guannan Wang,Bingyi Chen
Date01 October 2020
Published date01 October 2020
Accounting comparability and the value relevance
of earnings and book value
Bingyi Chen
| Ahmet C. Kurt
| Irene Guannan Wang
Department of Accounting, Sawyer
Business School, Suffolk University,
Boston, Massachusetts
Department of Accounting, Bentley
University, Waltham, Massachusetts
Irene Guannan Wang, Sawyer Business
School, Suffolk University, Boston, MA
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
accounting comparability, financial reporting opacity, internal controls, specialist auditors, value
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)
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;
to record the underlying transactions (e.g., De Franco,
Kothari, & Verdi, 2011; henceforth DKV).
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
literatureearnings 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 19962015, 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.
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.

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