In my dissertation, I study a new accounting standard update and its impact on U.S. public insurers’ financial reporting. The Financial Accounting Standard Board (FASB) recently issued Accounting Standards Update No. 2016-01, which requires firms to report unrealized gains and losses on available-for-sale (AFS) equity securities in net income, thus reducing firms’ability to manage or smooth earnings. Previously, these gains and losses were recorded in other comprehensive income and were not recognized in net income until the investments were sold. My dissertation examines the capital market consequences associated with this reporting change. Three questions are addressed. The first question is, whether this earnings reclassification changes the informativeness of financial reporting? Using data from U.S. public insurers, we find
a significant decrease in firms’ earnings response coefficient (ERC) after the application of this new standard, and that the mechanism explaining this reduction in ERC is a decrease in earnings persistence. This result suggests that, after the reporting change, earnings less fully reflect the information investors use when revising their beliefs about firm value around earnings announcements. However, ERC is only a reflection of the information usefulness of earnings. My second question is, whether the decrease in ERC leads to an increase in information asymmetry and investors’ perception of firm riskiness. Our evidence indicates no significant changes in investor assessment of overall firm risk following the reporting change. This result suggests that investors appear to understand that the reduction in earnings persistence is not reflective of a change in firm risk. The third question I addressed is, whether the classification of unrealized gains/losses into net income changes financial analysts’ forecast accuracy. I find evidence that there is no significant change in analysts’ forecast accuracy. Overall, these results indicate that the classification of unrealized gains/losses on AFS equity securities into net income reduces the persistence of earnings and reduces the extent to which earnings reflect the information investors use to revise their beliefs about firm value around earnings announcements, and that investors appear to recognize that these reductions in persistence are not a reflection of the firm performance becoming more volatile.
