The effect of SFAS 131 on the stock market’s ability to predict industry-wide and firm-specific components of future earnings

Abstract

This study examines the impact of SFAS 131 on the extent to which stock prices incorporate industry-wide and firm-specific components of future earnings. By decomposing earnings into industry-wide and firm-specific components, this paper finds that the firms that aggregated segments under the old rule experience significant acceleration in the incorporation of future earnings into current stock prices upon adoption of SFAS 131. However, the acceleration of future earnings is mostly driven by the improved incorporation of industry-wide components of future earnings, which indicates the market’s ability to predict firm-specific components is not significantly changed. Supplemental analysis suggests that the reduced geographic earnings information is one possible reason for lack of improvement in incorporating firm-specific earnings into price.