Financial Statement Comparability: Benets and Costs

This paper analyzes the bene…ts and costs of …nancial statement comparability from an information perspective. We …rst show analytically that while comparability enhances the correlation among …rms’reported earnings (“common informativeness”), it reduces …rms’own reporting precision (“individual informativeness”). Next, we provide theoretical justi…cation for the comparability measure of De Franco, Kothari, and Verdi (2011) and then show that it is negatively associated with implied volatility at annual earnings announcements. This result suggests that comparability, on average, improves earnings informativeness. More importantly, consistent with our model predictions, comparability’s net information bene…ts decrease when …rms’economic fundamentals are highly correlated (due to lower common informativeness) and/or volatile (due to lower individual informativeness). These results are robust to using …nancial 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 a potential information cost of increased comparability. JEL classi…cation: G01; G14; G18; M40; M41; M48 Key words: Financial Statement Comparability; Earnings Informativeness; Common Informativeness; Individual Informativeness; Implied Volatility; Fundamental Correlation; Fundamental Volatility; Financial Crisis; Recession; Merger Waves Please send correspondence to [email protected]. We are grateful to Rodrigo Verdi for sharing the codes to calculate the comparability measure of De Franco, Kothari, and Verdi (2011) and for answering numerous questions about the measure. The paper has also bene…ted greatly from comments by Jeremy Bertomeu, Judson Caskey, Gus De Franco, Alex Edmans, Pingyang Gao, Frank Gigler, Chandra Kanodia, Tjomme Rusticus, Lorien Stice-Lawrence, Clare Wang, Dan Wangerin, Michael Weisbach, and seminar participants at Michigan State University and University of Minnesota.