An Empirical Evaluation of Investment Income under the Equity Method of Accounting

Abstract

This study investigates the valuation implications of equity method earnings among Chinese listed firms, which are often perceived by the Chinese business press of employing the equity method to avoid reported losses. Our results show that firms with declining core earnings are more likely to have equity method investments than firms with increasing core earnings. Also, firms with lower core earnings report higher equity method earnings. Moreover, equity method earnings do not improve earnings persistence but are found to be relevant. Investors act as if they naively fixate on equity method earnings. A portfolio constructed on the basis of core earnings and equity method earnings generates a hedged return of 8%.

The use and usefulness of equity accounting

“…Using Norwegian data, Bøhren and Haug (2006) find firms with higher leverage try to maximise earnings through the choice of cost and equity accounting methods. Data from China show that equity accounting adopters are more likely to have a decline in core earnings (Lai et al ., 2019). Evidence also highlights the preferences for accounting depends on the nature of the jointly controlled entities (Lourenço and Curto, 2010).…”

Do Investors Perceive the Link Between Equity Method Earnings and Future Earnings? The Role of Supplemental Disclosures

“…Lai et al (2019), using a sample of Chinese listed firms, find that equity method earnings do not increase earnings persistence. However, their analysis does not specifically examine the link between the separate components of current earnings into future earnings.…”