The Effect of Changes in Japanese Consolidation Policy on Analyst Forecast Error

Posted: 20 Sep 2006

See all articles by Don Herrmann

Don Herrmann

Oklahoma State University - Stillwater - School of Accounting

Wayne B. Thomas

University of Oklahoma

Tatsuo Inoue

Kwansei Gakuin University - Business School

Abstract

Our broad research objective is to investigate whether convergence towards international standards improves the decision usefulness of information. Recent changes in Japanese consolidated reporting practices to better align with international standards provide an excellent setting to investigate this research objective. Specifically, we examine the effect of changes in Japanese consolidation policy on financial analysts' perceptions of the persistence of subsidiary earnings. Previous research provides evidence that, prior to the change in consolidation policy, consolidated financial information was not used efficiently in the Japanese capital market. Prior research finds a positive relation between subsidiary earnings and future stock returns in Japan, indicating that investors underestimate the persistence of subsidiary earnings. Consistent with prior research using stock returns, we find that financial analysts also underestimate the persistence of subsidiary earnings in Japan. We document a significant positive relation between subsidiary earnings and future forecast errors of consolidated earnings. However, following the changes in consolidation policy in Japan, we find that financial analysts no longer underestimate the persistence of subsidiary earnings. Changes in Japanese consolidation policy in conformance with international standards increase decision usefulness by improving the ability of financial analysts to predict overall firm performance. One limitation of our research design relates to the adoption of mandated accounting policy changes by all sample firms in the same calendar time. This makes it difficult to control for the impact of correlated omitted variables. While this concern can never be completely eliminated, we provide additional tests that examine sample partitions by firm size and industry. These additional tests support the primary findings that Japan's efforts to converge consolidation rules with international standards have improved analysts' consolidated earnings forecasts.

Keywords: Consolidation policy, forecast error, convergence, parent, subsidiary

JEL Classification: M41

Suggested Citation

Herrmann, Don and Thomas, Wayne B. and Inoue, Tatsuo, The Effect of Changes in Japanese Consolidation Policy on Analyst Forecast Error. Journal of Accounting and Public Policy, January/February 2007, Available at SSRN: https://ssrn.com/abstract=931200

Don Herrmann (Contact Author)

Oklahoma State University - Stillwater - School of Accounting ( email )

College of Business Administration
345 Business Building
Stillwater, OK 74078
United States

Wayne B. Thomas

University of Oklahoma ( email )

Michael F. Price College of Business,
307 W Brooks, Rm 212B
Norman, OK 73019
United States
405-325-5789 (Phone)
405-325-7348 (Fax)

Tatsuo Inoue

Kwansei Gakuin University - Business School ( email )

Department of Accounting
Nishinomiya
Japan

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