PREDICTING CONSOLIDATED EARNINGS IN JAPAN: THE INCREMENTAL USEFULNESS OF SUBSIDIARY EARNINGS

Abstract

Despite the wide acceptance of consolidated earnings worldwide, parent-only financial statements have historically been the primary financial statements in Japan. We examine whether subsidiary earnings in Japan are incrementally useful in predicting consolidated earnings beyond the information already available in parent-only earnings. For each of the six primary earnings levels reported in Japan (sales, gross profit, operating income, current income, earnings before taxes, and net income), we find that the persistence of subsidiary earnings is similar to or greater than the persistence of parent-only earnings in explaining year-ahead consolidated earnings. Consistent with expectations based on earnings persistence, we find that, for each of the six earnings levels examined, subsidiary earnings improve the predictability of consolidated earnings beyond the information already found in parent-only earnings. Furthermore, we find that firm-specific characteristics such as the ratio of subsidiary assets to consolidated assets and the persistence of subsidiary earnings are related to the usefulness of subsidiary earnings in predicting consolidated earnings.