Value Relevance of the Multi-step Income Statement in Japan

Takashi Obinata and Kazuyuki Suda
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Takashi Obinata: Faculty of Economics, University of Tokyo
Kazuyuki Suda: Graduate School of Finance,Accounting & Law, Waseda University

No CARF-F-061, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: This paper investigates the relationship between value relevance of the multi-step income statement and managerial opportunistic behavior. In Japan, net income is disclosed by three steps, i.e., 1) operating profits from core operating activity, 2) ordinary income, measured by adding gains and losses from non-core operating and financing activities to operating profits, and 3) net income that is bottom line performance in the income statement. While Japanese firms achieve income smoothing, loss avoidance and big bath, the managerial opportunistic behavior is simply identified by the observation of multi performance measures. We find that the firms doing income smoothing, loss avoidance and big bath, which are identified by the multi-step income statement, have the different value relevance of earnings from other firms. In many cases, earnings management decreases the value relevance of earnings. The results suggest that the multi-step income statement enables investors to detect earnings management without apparent difficulty and that earnings become more useful when investors use the information contained in it.

Pages: 36 pages
Date: 2006-03
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