Evidence of the Relation between Accounting for Equity Investments and Equity Valuation
JOURNAL OF ACCOUNTING, AUDITING, AND FINANCE, Vol 11, No 4, Fall 1996
Posted: 18 Apr 1998
Abstract
This study documents differences in the valuation of passive and nonpassive equity investments by correlating investor and investee security returns at investee dividend and earnings announcements. Accounting procedures for equity investments differ by the type of investment income recognized by investors. According to the revenue recognition rules of SFAS No. 115, investor firms with passive investments recognize investment income from investee dividends and some market value changes. According to the revenue recognition rules of APB Opinion No. 18, investors with nonpassive investments recognize investment income as investee income is earned. The correlations of investor and investee security returns suggest an association between passive and nonpassive investor valuation and investee dividend and earnings announcements that corresponds to the accounting revenue recognition procedures for equity investments. Analysis of the relative timing of investor and investee announcements indicates that the results are not due to a naive fixation on accounting revenue recognition events. Rather, the results suggest differences in the substance of the investor-investee relation between passive and nonpassive investments. The results are robust to alternative specifications and controls for relative investment size and industry affiliation.
JEL Classification: G12, M41, M44
Suggested Citation: Suggested Citation