Disclosure-Derived Financial Statement Adjustments in Equity Valuation

Abstract

In this paper, we assess the equity value relevance of disclosure-derived financial statement adjustments. Prior literature has explored only the incremental explanatory power of individual adjustments, or has assessed the superiority of earnings recast using only a subset of prescribed adjustments. Measurement error differences among different adjustments may, however, mitigate aggregated adjustments’ relative or incremental explanatory power. In price levels and returns tests, we find that reported financial numbers have relatively superior explanatory power over adjusted numbers, though adjustments still retain economically significant incremental explanatory power above reported numbers alone. We find a severe loss of information upon aggregating different adjustment categories and find that adjustments for nonrecurring income items, operating leases, pensions, and LIFO reserves have highly economically significant effects on equity valuation. Results suggest that financial statement adjustments complement, rather than substitute for, reported financial numbers and that aggregating disparate adjustments together severely diminishes their valuation relevance.