The Choice of Fiscal Year and the Earnings–Return Relationship

• Author: Taekyu Kim,Sang Hyun Park,Martin J. Dierker
• Published date: 01 August 2019
• DOI: http://doi.org/10.1111/ajfs.12270
• Date: 01 August 2019

The Choice of Fiscal Year and the Earnings–

Return Relationship*

Martin J. Dierker

College of Business, Korea Advanced Institute of Science and Technology (KAIST), Republic of Korea

Taekyu Kim**

College of Business, Hallym University, Republic of Korea

Sang Hyun Park

College of Business, Korea Advanced Institute of Science and Technology (KAIST), Republic of Korea

Received 2 November 2018; Accepted 26 January 2019

Abstract

The positive earnings–return relationship is weaker for US-listed firms with a calendar fiscal

year. Furthermore, stock returns for these firms are more positively related to industry earnings,

as a common fiscal year-end improves comparability of earnings. December fiscal year-ends are

more frequent among large and low market-to-book industries and firms, consistent with firms

trading off the benefits of better comparability against the associated higher accounting and

auditing costs. Our results imply that the prevalence of a single standard for fiscal year-ends in

other Asia–Pacific economies is indeed beneficial, as it promotes market transparency.

Keywords Earnings–return regression; Fiscal year choice; Transparency

JEL Classification: G.14, G.32

1. Introduction

The fiscal year is the basic unit of operation of a firm. Across the Asia–Pacific

region, there is profound variation in how firms choose this basic unit of operation.

For instance, in Japan and India, firms predominantly choose a fiscal year that

starts in April and ends in March. In China and South Korea, on the other hand,

*We thank the editor and two anonymous referees; Tom George, Nisan Langberg, Praveen

Kumar, Shiva Shivaramakrishnan, and Ron Singer for insightful comments; and Joe Dew-

berry for kindly editing the paper. All remaining errors are our responsibility.

**Corresponding author: College of Business, Hallym University, 1 Hallymdaehak-gil, Chun-

cheon, Gangwon-do 24252, Republic of Korea. Tel: +82-33-248-1857, Fax: +82-33-248-1804,

email: tkim@hallym.ac.kr.

Asia-Pacific Journal of Financial Studies (2019) 48, 503–530 doi:10.1111/ajfs.12270

©2019 Korean Securities Association 503

most firms choose the calendar year from January to December as their fiscal year.

1

In the United States, the latter is also common, but there is profound cross-sec-

tional variation across and within industries. The choice of this basic unit of opera-

tion for the firm is known to have important effects on the way a firm operates.

For instance, Oyer (1998) shows that fiscal year-ends create significant business sea-

sonality. One channel for this is the dynamic optimization by employees in

response to popular non-linear incentive schemes, which is shown to cause signifi-

cant variation in pricing, effort provision, and the timing of sales.

In this study, we first ask whether the choice of fiscal year, in addition to its

aforementioned effects on how the firm operates, also matters in financial markets.

Specifically, we analyze how the link between stock returns and firm and industry

earnings depends on the choice of fiscal year. We then conduct empirical tests to

confirm that firms’ fiscal year choice has significant consequences for the way mar-

kets incorporate information, and thus on the returns of firms’ equity.

Second, we build on these insights to analyze firms’ incentives for the choice of

fiscal year, and then study variation in fiscal year-ends empirically across and within

industries. The large amount of cross-sectional variation in this basic choice across

US firms is well known, as more than 30% of the firms in our sample have fiscal

years that do not end in December. While there are some examples of operating

reasons such as seasonality driving the choice of fiscal year-ends,

2

there is no com-

prehensive understanding of what drives this choice. Why only 44% of furniture

manufacturers have fiscal years ending in December, but 78% of lumber and wood

producers, and 83% of paper companies do, is a puzzle.

3

Furthermore, the large

degree of intra-industry variation suggests that there must be important firm-speci-

fic factors driving the choice of fiscal year in addition to factors such as revenue

seasonality, which are likely to affect an entire industry.

While we are interested in understanding the cross-sectional variation in fiscal

year-ends, it is nevertheless important to recognize that many firms cluster their fis-

cal year-ends in the same month. Specifically, we ask why 65% of public US corpo-

rations in our sample choose the calendar year as their fiscal year, given the peak of

demand on accountants’ and auditors’ time around the turn of the year. Clearly,

precious resources could be conserved by spreading fiscal years more evenly around

1

For instance, over 99% of Chinese firms in Datastream adopted a calendar fiscal year in

2014, while more than 96% of Indian firms chose a March fiscal year-end for the same per-

iod. See Section 6 for more details on fiscal year choices in Asia–Pacific economies. Anecdo-

tal evidence on the choice of fiscal year and examples of firms that changed their fiscal year

are provided in Sections 4 and 6.

2

For instance, most retailers and department stores have fiscal years ending in January, when

inventories are lowest after the busy Christmas holiday. See below for details.

3

Based on year 2014 Compustat data, as discussed later. Industry classification is based on

the two-digit SIC code according to the US Department of Labor.

M. J. Dierker et al.

504 ©2019 Korean Securities Association