Financial Statement Similarity

Abstract

We propose financial statement similarity as a measure of financial reporting comparability. The firm-pair version of our measure reflects the degree to which two firms report similar relations within their financial statement items; this version can help managers and market participants identify peer firms. The firm-year version of our measure reflects the degree to which a firm reports relations within its financial statement items that are similar to other members of its industry; this version can help market participants, regulators, and auditors screen firms for further attention. Our measure uses the presence and amounts of almost all financial items reported by a firm. We validate our measure in four sets of analyses to establish concurrent validity and in three sets of analyses to establish predictive validity. In all these tests, we contrast our measure with the comparability measure of De Franco et al. (2011) and a multivariate measure that considers only the presence, not amounts, of financial statement items. Our measure outperforms the alternatives and can be a useful tool for users.

Keywords: comparability; similarity; financial reporting; peer firms; benchmark firms.

JEL Classification: M2, M4, and G3