Comprehensive Income, Future Earnings, and Market Mispricing

Abstract

This paper examines the usefulness of comprehensive income disclosures as required by the Statement of Financial Accounting Standard (SFAS) No. 130, Reporting Comprehensive Income. In particular, we examine the implication of current period ‘other comprehensive income’ (OCI) for subsequent period income and whether the stock market fully recognizes the implications of current period OCI for future periods as reflected in stock prices. The results in the paper are consistent with the notion that OCI reported under SFAS No.130 is incrementally useful in predicting one-year ahead net income. We also find that while the market correctly impounds the implication of current period net income for next period net income, it does not reflect the implications of current period OCI for subsequent period net income. Based on this mispricing, we provide evidence that it is possible to have a profitable investment strategy. Specifically, we show that a zero-investment strategy based on current period OCI yields an abnormal return of 5.4 percent over a one year period even after controlling for other correlated variables. However, given the specifics of the form of discloser requirements under SFAS No. 130, we find that the extent of this mispricing is smaller in the post-SFAS No. 130 period than in the pre-SFAS No. 130 period. This is perhaps attributable to the effectiveness of the disclosures under SFAS No. 130.

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