The incremental informativeness of public subsidiary earnings

• Pages: 272-290
• Published date: 08 May 2018
• Date: 08 May 2018
• DOI: https://doi.org/10.1108/IJAIM-01-2017-0007
• Author: Abbie Daly
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

The incremental informativeness

of public subsidiary earnings

Abbie Daly

Accounting Department, University of Wisconsin-Whitewater, Whitewater,

Wisconsin, USA

Abstract

Purpose –This study aims to investigate how holding public subsidiaries affects the information

environmentof consolidated entities in Germany.

Design/methodology/approach –The sample consists of Germanconsolidated entities that are traded

on major German stock exchangesover the fiscal years 2005-2012 and hold subsidiarieswith public common

equity. The informativenessof earnings, defined as the association between earningsand returns, is used to

investigatehow holding public subsidiaries affects the information environmentof consolidated entities.

Findings –Findings suggest that public subsidiary earnings are incrementally informative about

consolidatedentity returns beyond both consolidated and segment earningsreported by consolidated entities

in Germany. An investigationinto the factors that affect the incremental informativenessof public subsidiary

earnings reveals that public subsidiaryearnings are more incrementally informative when, comparedto the

consolidatedentity, they are relatively large, have dissimilargrowth prospects and are from the samecountry

(i.e. Germany).

Practical implications –These findings suggest thatthis disclosure is useful to investors and that this

type of disclosurecould be valuable to adopt in other countries thatdo not have this disclosure requirement.

Originality/value –These findings contribute to the streams of literature that: investigate ways that

regulators can improve the information environment of corporations, compare the informativeness of

accountingmeasures and investigate the informativeness of subsidiaryinformation.

Keywords Germany, Stock returns, Consolidation, Public subsidiaries, Subsidiary earnings

Paper type Research paper

1. Introduction

There is a growing global concern over the amount of disclosures required in corporate

annual reports. Ernst and Young (2012) reports thatthe average number of pages in annual

reports devoted to footnotes and Management’s Discussion and Analysis has quadrupled

over the past 20 years. In addition to preparationcosts, many have expressed concerns that

it could lead to “information overload”, whereby investors have difficulty identifying the

most relevant information and make worse decisions than if less information were made

available to them(Paredes,2003, 2013;White, 2013;Peach and Hamidi-Ravari,2015).

Accordingly, both the International Accounting Standards Board (IASB) and USA

Financial Accounting Standards Board (FASB) have initiated projects concerning

The author gratefully acknowledges the support and guidance of the dissertation committee at the

University of Wisconsin-Madison: Terry Warfield (chair), Mark Fedenia, Brian Gould, R.D. Nair and

Holly Skaife. The author also acknowledges the helpful comments and suggestions from Amanda

Convery and workshop participants at the University of Wisconsin-Madison, Han Wu and

participants at the 2015 AAA IAS Midyear Meeting, participants at the Fifth International

Conference of The Journal of International Accounting Research and from three anonymous

reviewers. The author also appreciates the excellent editorial support provided by Editor Maggie Liu.

IJAIM

26,2

272

Received30 January 2017

Revised30 June 2017

Accepted23 July 2017

InternationalJournal of

Accounting& Information

Management

Vol.26 No. 2, 2018

pp. 272-290

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-01-2017-0007

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

disclosures. As it relates to concerns about information overload, in its March 2017

discussion paper, the IASB stated that “the Board received feedback that financial

statements are increasinglyperceived as burdensome to prepare and that there are concerns

about how well they meet the needs of their primary users”and as stated on the FASB’s

project page, “Although reducing the volume of the notes to financial statements is not the

primary focus, the Board hopes that a sharper focus on important information will resultin

reduced volume in most cases[1].”Standards-setters are therefore faced with the daunting

task of evaluating theusefulness of specific corporate disclosures.

This study focuses on evaluating the usefulness of one specificcorporate disclosure that

is currently required in Germany. Specifically, Section 313 of the German Commercial Code

(HGB) requires companies to disclose the names and percentage ownership held of all

subsidiaries accounted for in the consolidated financial statements[2]. While this disclosure

permits investors in consolidated entities to seek additional information about the

subsidiaries comprising the consolidated accounts, additional information about wholly

owned subsidiaries is generally not publicly available. However, investors can use this

disclosure to seek additional information aboutsubsidiaries that are publicly traded. Being

publicly traded, these subsidiaries are not only required to prepare their own financial

reports but may also be covered by analysts,the media, etc. This information can be used as

a source of information beyond that reported by the consolidated entity. Therefore, this

study investigates whether publicsubsidiary earnings are incrementally informative about

consolidated entityreturns beyond consolidated entity earningsin Germany.

The study investigates this research question using a sample of German consolidated

entities that are traded on major German stock exchanges over the fiscal years 2005-2012 and

hold subsidiaries with public common equity. The informativeness of earnings, defined as the

association between earnings and returns, is used to investigate how holding public

subsidiaries affects the information environment of consolidated entities. Findings suggest that

public subsidiary earnings are incrementally informative about consolidated entity returns

beyond both consolidated and segment earnings reported by consolidated entities in Germany.

Further, an investigation into the factors that affect the incremental informativeness of public

subsidiary earnings reveals that public subsidiary earnings are more incrementally

informative when, compared to the consolidated entity, they are relatively large, have

dissimilar growth prospects and are from the same country (i.e. Germany).

This study contributes to three streams of literature. First, this study contributes to the

literature that investigates ways that regulators can improve the information environment of

corporations (Ji et al., 2015,Harymawan and Nowland, 2016;Dayanandan et al.,2016). Second,

by comparing the informativeness of consolidated and segment earnings reported by the

consolidated entity and earnings reported by their public subsidiaries, this study contributes to

the literature that compares the informativeness of different accounting measures (Dechow,

1994;Cheng et al., 1996;Dechow et al., 1998;Cheng et al., 2013) and different levels of

aggregation of accounting measures (Barth et al., 1992;Lipe, 1986;Ohlson and Penman, 1992;

Ramakrishnan and Thomas, 1998), as well as accounting measures reported by an entity

relative to other information sources (Ball and Shivakumar, 2008;Basu et al., 2013).

Finally, this study contributes to the literature that investigates the informativeness of

subsidiary information (Goncharov et al., 2009;Harris et al., 1994;Hermann et al.,2001,2002;

Müller, 2011;Niskanen et al., 1998). These studies focus on proving the value of consolidation

by providing evidence that consolidated accounts are more informative than parent-only

accounts. They do so by providing evidence of the incremental informativeness of subsidiary

earnings over parent-only earnings. Because the purpose of these studies is only to prove the

value of consolidation, these studies do not provide evidence on whether subsidiary earnings

Public

subsidiary

earnings

273