Does financial reporting above or below operating income matter to firms and investors? The case of investment income in China

Mei Luo (), Shuai Shao () and Frank Zhang ()
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Mei Luo: Tsinghua University
Shuai Shao: Zhejiang University
Frank Zhang: Yale University

Review of Accounting Studies, 2018, vol. 23, issue 4, No 14, 1754-1790

Abstract: Abstract We explore a unique regulatory change in China in 2007 that moves investment income in an income statement from below the line of operating income to above the line. We find that, post-regulatory change, firms report high investment income when core earnings (operating income excluding investment income) are low and vice versa. Investment income and core earnings exhibit a significantly negative correlation every year post regulation, in contrast to a significantly positive correlation beforehand. We also find that investors do not fully see through the change. Before the regulation, both core earnings and investment income are positively correlated with contemporaneous stock returns and uncorrelated with future stock returns, suggesting appropriate pricing of the information. However, afterward, the results on core earnings are similar to those in the pre-regulation period, but investment income is negatively correlated with future stock returns, implying that the stock market overreacts to the information in investment income in the contemporaneous year.

Keywords: Core earnings; Investment income; Operating income; Mispricing (search for similar items in EconPapers)
JEL-codes: G12 G14 M40 M41 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s11142-018-9455-1

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