The Predictive Ability of Geographic Segment Information at the Country, Continent, and Consolidated Levels

Abstract

This study examines whether geographic information disclosed at an increasingly disaggregated level (specifically, consolidated vs. continent vs. country) results in increased predictive ability of company operations (specifically, sales, gross profit, and earnings). Multinational corporations (MNCs) are formed using a simulated merger approach by combining the annual operating results of six individual firms, one from each of six countries. This approach makes it possible to compare the forecasting accuracy of data disclosed at the country, continent, and consolidated levels, not possible using current geographic segment disclosures. Previous studies using year‐ahead forecast models implicitly assume the predictive factors included in the models are significant in forecasting operating results. Using regression forecast models, this study tests whether the predictive factors included in the models are effective in forecasting operating results by examining the direction, size, and significance of the regression coefficient estimates. The coefficients provide evidence that exchange rate changes, inflation, and real GNP growth are useful in forecasting annual sales and gross profit. Whereas, at least for this sample and this time period, exchange rate changes, inflation, and real GNP growth are not significant variables in forecasting annual earnings. The results indicate that the accuracy of forecasts increase as sales and gross profit are disclosed at a more disaggregated geographic level. The hypothesized relationship between consolidated, continent, and country levels, while holding strongly under perfect foresight, holds to a lesser extent using forecasts of exchange rates, inflation, and real GNP.

Pricing and Mispricing Effects of SFAS 131

“…Street et al (2000) report that the consistency of segment information and the number of total segments reported increased significantly with the introduction of SFAS 131. Based on these findings, the authors conclude that business reporting improved with SFAS 131 (see also Herrmann and Thomas, 2000;and Berger and Hann, 2003). Similarly, a 1998 report by Bear Stearns emphasizes the improvement in the consistency of descriptions of the business throughout the president's letter, management discussion and analysis, and notes.…”

“…Regarding geographic segment disclosures, prior research suggests that, under certain conditions, such disclosures potentially enhance predictability of consolidated amounts (e.g., Balakrishnan et al, 1990;Nichols et al, 1995;Herrmann, 1996;and Lobo et al, 1998). However, user groups complained that firms' disclosure practices under SFAS 14 were inadequate and research has shown that investors did not use SFAS 14 geographic segment earnings disclosure in valuing securities (Boatsman et al, 1993).…”

“…Many users complained that such broad, regional disclosures were of limited use. Herrmann and Thomas (2000) document that for enterprise-wide disclosures; the proportion of country-level geographic segments has increased, while the proportion of broader geographic area segment disclosures has decreased (see also Hope et al, 2008). With more country-level disclosures, investors should better assess the impact of various business factors (e.g., inflation, exchange rates, competition, market share, political forces, etc.)…”

“…He conjectures but does not test for the possibility that this 'discount' is explained by low-quality disclosure related to foreign operations. Herrmann and Thomas (2000), Street et al (2000), Behn et al (2002) and Hope et al (2008) all document an improvement in foreign operations disclosure following the implementation of SFAS 131 (e.g., the reporting of each material country instead of broad regional disclosures). If segment disclosures under SFAS 131 represent an improvement to investors in forecasting future earnings and hence valuing the firm more accurately, then the valuation discount applied to foreign earnings and the noisiness of the foreign earnings signal should decrease after the introduction of the new accounting standard.…”

The materiality of country-specific geographic segment disclosures

“…3 Only Canada and the U.K. were disclosed by a sufficient number of firms to be incorporated in tests of association with security prices (Boatsman, Behn and Patz, 1993;Nichols, Tunnell and Waldrup, 1996;Thomas, 2000). Using a simulation approach to assess the predictive ability of geographic segment information, Herrmann (1996) is able to expand this group of countries to include France, Germany, and Japan. In general, the results of these studies suggest that individual country disclosures can be useful.…”