Simulated Mergers of Existent Autonomous Firms: A New Approach to Segmentation Research

Abstract

After a decade of debate and experimentation, new guidelines for segment reporting were issued by the Financial Accounting Standards Board (FASB [1976; 1977]) and the Securities and Exchange Commission (SEC [1977; 1978]). These guidelines, which pertain to American diversified companies, prescribe various subentity disclosures including segmented sales and earnings. The purpose of this paper is to suggest a new approach to evaluating segmental disclosures. Simulated mergers of existent, autonomous, singleproduct firms are used to provide evidence regarding differences in predictive ability between income forecasts based on consolidated (CN) earnings and corresponding forecasts based on segmented (SG) earnings. Research on this predictability issue began with Kinney [1971] and was later extended by Collins [1976]. As expected, they found forecasts based on SG data to be generally superior in terms of predictive ability. The results, however, did cast doubt on the predictive ability of segmented earnings, in that income forecasts based jointly on SG sales and SG margins did not outperform forecasts based jointly on SG sales and CN margins. The generalizability of the Kinney-Collins results, however, was limited due to data constraints. They were based on limited quantities of published annual data, and a common set of the prediction models could not