Investing in Your Own Equity: Effects of Fair Value Accounting and Comprehensive Income Recognition on Earnings and Price Volatility

50 Pages Posted: 20 Jul 2004

See all articles by Robert J. Bloomfield

Robert J. Bloomfield

Cornell University - Samuel Curtis Johnson Graduate School of Management

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management

Steven D. Smith

Brigham Young University

Date Written: July 20, 2004

Abstract

Firms can effectively take long or short positions on their own equity by holding treasury shares, contributing their shares to their pension fund, write put or call options on their stock, compensate employees with stock options, or invest in other entities (e.g., other firms, stock indexes) that hold shares of their stock. In each of these circumstances, fair value accounting methods can allow firms to report on these "self-generated" unrealized gains or losses ("UGLs").

In this paper we present a model and experimental evidence indicating that, if investors attend to unrealized gains and losses (UGLs) associated with a firm's own equity, equity price changes reflect through subsequent periods to create high volatility and predictable autocorrelations in price. Our results provide evidence that the reflection-induced volatility is determined by an interaction between the extent of the self-investment and the prominence of the self-generated UGLs on the primary reporting statement (with comprehensive income performance statements providing high prominence).

Keywords: Fair-value accounting, comprehensive income, functional fixation, market efficiency, experiments

JEL Classification: G14, M41

Suggested Citation

Bloomfield, Robert J. and Nelson, Mark W. and Smith, Steven D., Investing in Your Own Equity: Effects of Fair Value Accounting and Comprehensive Income Recognition on Earnings and Price Volatility (July 20, 2004). Available at SSRN: https://ssrn.com/abstract=566801 or http://dx.doi.org/10.2139/ssrn.566801

Robert J. Bloomfield (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

450 Sage Hall
Ithaca, NY 14853
United States
607-255-9407 (Phone)
607-254-4590 (Fax)

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

448 Sage Hall
Ithaca, NY 14853
United States
607-255-6323 (Phone)
607-254-4590 (Fax)

Steven D. Smith

Brigham Young University ( email )

531 TNRB
Provo, UT 84602
United States
801-422-1969 (Phone)

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