Consistency As a Path to Comparability: Benefits and Costs
50 Pages Posted: 25 Oct 2016 Last revised: 12 Mar 2018
Date Written: March 9, 2018
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 channel") while reducing firms' own reporting precision ("standalone channel"). The model generates two testable predictions. First, firms' fundamental correlation diminishes the information gains via the spillover channel. Second, fundamental volatility exacerbates the information losses via the standalone channel. 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 firms' information environment.
Keywords: Financial Statement Comparability; Reporting Precision; Information Spillover; Implied Volatility; Fundamental Correlation; Fundamental Volatility; Financial Crisis; Recession; Merger Waves
JEL Classification: G01; G14; G18; M40; M41; M48
Suggested Citation: Suggested Citation