The Balance Sheet Approach to Earnings Measurement and Investors' Reaction to Accounting Disclosures

Abstract

This study examines how standard setters’ balance sheet approach influences investors’ reaction to accounting disclosures. I construct a novel standard-specific measure of the balance sheet approach, and I find some evidence that as the balance sheet approach of standards increases, investors’ reaction to earnings announcements decreases for firms that rely on these standards. To further examine the decreased reaction, I examine two types of firms that provide balance sheet information at the earnings announcement: firms that concurrently file a 10-K and firms that voluntarily disclose balance sheet information. If balance sheet information takes on increased importance under the balance sheet approach these firms may not experience a decrease in investor reaction. While I find that investors’ reaction to earnings is relatively stronger for concurrent filers, firms that voluntarily disclose balance sheet information at the earnings announcement do not have the same increase and some evidence points to a decrease. These results suggest that the balance sheet approach leads to accounting disclosures that are generally less informative, and they suggest a possible new role for balance sheet information.