Aggregation and Accounting Informativeness

Daniel A. Bens
daniel.bens@insead.edu
INSEAD Accounting and Control Area
Boulevard de Constance
F-7705 Fontainebleau Cedex, 77305
France

Steven J. Monahan
steven.monahan@insead.edu
INSEAD Accounting and Control Area
Boulevard de Constance
F-7705 Fontainebleau Cedex, 77305
France

Logan B. Steele
lsteele@bus.wisc.edu
University of Wisconsin
School of Business, Accounting & Information Systems Department
975 University Avenue
Madison, WI 53706

September 4, 2015

This paper has benefitted from comments and suggestions from Peter Easton, Mozaffar Khan, Stephen Ryan, and
workshop participants at the HEC-INSEAD Accounting Colloquium, London Business School, New York University,
Tilburg University, and the University of Arizona. We are solely responsible for any errors.
 Aggregation and Accounting Informativeness

Abstract

In a sample of U.S. multiple-segment firms we document a negative association between

aggregation and the accounting systems ability to communicate bad economic news. Aggregation,
as reflected in firms reported organizational structures (the definition and characteristics of their
segments), results in some multiple-segment firms exhibiting lower cross-segment variation in
profitability (Hayes and Lundholm 1996). We find that firms that are engaging in such aggregation
have accounting systems that provide less timely information about economic losses. Our results
hold for a variety of approaches to measuring the extent to which accounting earnings reflect bad
economic news in a timely manner. We provide initial evidence supporting Beyer et al. (2010) and
Bergers (2011) contention that accounting informativeness is, in part, a function of managers
aggregation choices.

Keywords: accounting choice; aggregation; conservatism; impairments; segment reporting;

special charges
1. Introduction

We examine how a firms reported organizational structure affects the extent to which

accounting earnings provide timely information about bad economic news. The issue of how

aggregation influences accounting informativeness has received little attention in the accounting

literature. Rather, the extant research generally focuses on how segment-level aggregation is

determined (Harris (1998); Berger and Hann (2007)). We test whether the aggregation of

heterogeneous operations into segments that are more homogeneous in appearance: (1) reduces

the probability of reporting significant negative accruals when other indicators of

underperformance are present and (2) results in firm-level earnings that exhibit a relatively weak

association with contemporaneous bad economic news.

We describe a two-step process that leads to delayed accounting recognition of bad

economic news. We refer to the first step of this process as ex ante aggregation. Ex ante

aggregation occurs at the point in time when the managers of a firm define its segments for external

reporting purposesi.e., before segment earnings are determined. Ex ante aggregation reflects the

commingling of heterogeneous operations into a homogeneous segment. This is not equivalent to

reporting a single segment for the entire firm. On the contrary, our primary sample consists of

multiple-segment firms. Rather, ex ante aggregation simply implies that some of the externally-

reported segments comingle operations that exhibit significant differences in terms of economic

fundamentals.

We refer to the second step of this process as ex post offsetting, which occurs at the point

in time when segment earnings are determined. Ex post offsetting might manifest itself in several

ways. First, unrecognized gain reserves (i.e., when asset fair values exceed book values) can be

offset against unrecognized losses when a group is tested for impairment. In particular, even if the

1
fair values of some assets in a group have fallen below their carrying values (i.e., there are

unrecognized losses), an impairment loss is not recorded if the gain reserves on other assets within

the group exceed the unrecognized losses. We examine the issue directly by analyzing the

propensity to record asset impairments and how this varies in the cross-section with our

aggregation proxy.

A second type of ex post offsetting occurs when agency problems within segments go

uncorrected as heterogeneous operations are commingled. Specifically, abnormally good

performance from certain operations can be commingled with poorer performing ones. The

resulting average performance reduces the pressure to take managerial action. We examine this

issue directly by analyzing the propensity to record restructuring charges and other negative special

items, and how this varies in the cross-section with our aggregation proxy. 1

In summary, the first step of ex ante aggregation increases the heterogeneity of one or more

segments operations, which, in turn, increases managements ability to conduct ex post offsetting.

As a segments operations become more heterogeneous, there is a greater likelihood that the

segment will simultaneously have unrecognized gain reserves and: (1) some operations that are

underperforming or (2) some assets with carrying values above their fair valuesi.e.,

unrecognized losses. Hence, managers who define segments broadly ex ante have greater ability

to carry out ex post offsetting.

An important consequence of ex ante aggregation and ex post offsetting is that there is less

cross-segment variation in profitabilityi.e., there is a variance effect. If the managers of a

multiple-segment firm use ex ante aggregation and, thus, commingle unrelated activities within

1
A third form of ex post offsetting occurs if gain reserves (i.e., assets that have fair values that exceed their book
values) are realized in earnings via the liquidation of the related assets in order to offset the underperformance of
some of the segments other activities. This form of ex post offsetting would be fairly transparent if the gains are
explicitly disclosed as positive one-time items on the income statement.

2
the reported segments, the firms segment-level profits will exhibit relatively low dispersion. That

is, ceteris paribus, an increase in within-segment heterogeneity implies a decrease in cross-

segment heterogeneity. Multiple-segment firms will also have relatively low dispersion in segment

profits if managers conduct ex post offsetting within the segments they manage. While this

variance effect has been discussed extensively in the segment disclosure literature (e.g., Hayes and

Lundholm 1996), our contribution is to use it to examine the implications of ex ante aggregation

and ex post offsetting for timely loss recognition.

We take advantage of the variance effect to develop a new empirical measure of

aggregation for a sample of multiple-segment firms. For each multiple-segment firm in our sample,

we create a proxy that is a decreasing function of the firms cross-segment variation in profitability.

Hence, higher values of our proxy, which we refer to as R_SR, imply greater aggregation. 2 We

hypothesize that R_SR has a negative association with the timely accounting recognition of bad

economic newsan issue that is vital for both the valuation and stewardship roles of financial

accounting. We also form an alternative measure of managers aggregation choices by employing

the implementation of SFAS 131 as a setting in which previously hidden segments were

revealed. This alternative measure has the benefit of comparing each firm with itself across time

and of being exogenously determined at the firm level. We predict that SFAS 131 led to the

disclosure of previously aggregated operations, which, in turn, led to more timely recognition of

bad economic news.

Our evidence strongly supports our hypothesis. First, we evaluate the relation between

R_SR and various nonrecurring charges including asset impairments, restructurings, and special

2
We provide a detailed description of how R_SR is calculated and the steps we take to increase its construct validity
in Section three; additional validity tests are in Section 6. The acronym stands for Ranked_Standard deviation Ratio.
This is the ratio of the standard deviation of a set of single segment firms profit margins to the standard deviation of
a multiple-segment firms profit margins across its segments matched by industry to the firms in the numerator.

3
items. We study these charges because they are a set of observable accounting accruals that directly

communicate bad economic news to financial statement users. Using both Probit and Tobit models,

and controlling for various fundamentals that determine nonrecurring charges, we show that there

is a negative association between R_SR and the likelihood that a firm reports a special charge in a

particular fiscal year.

We then broaden our view of accounting beyond special charges and examine how R_SR

influences the association between negative stock returns and accounting earnings. Basu (1997)

first documented that earnings exhibit a stronger association with bad economic news (captured

by negative stock returns) vis--vis good economic news (positive stock returns). We demonstrate

that this association between earnings and negative economic news declines as R_SRi.e., the

degree of aggregationincreases.

The conclusions above are corroborated by our alternative measure of aggregation. In these

tests we find that the association between earnings and bad economic news increases for firms

that, upon adopting SFAS 131, revealed segments that were hidden under the previous segment

reporting rules (i.e., SFAS 14).

We contribute to the extant literature in two ways. First, our results shed light on how a

firms reported organizational structurei.e., the definition and characteristics of its segments

affects the extent to which accounting earnings reflect contemporaneous bad economic news.

Hence, we add to the body of literature that considers how conservatism varies across accounting

and regulatory regimes (e.g., Ball, Kothari and Robin (2000), and Bushman and Piotroski (2006)),

as well as operating and financing environments (e.g., Khan and Watts (2009)). We also respond

to the call from Beyer et al. (2010) and Berger (2011) for more research on the effects of managers

aggregation policies.

4
 Second, we provide additional evidence on the reporting choices made by managers of

multiple-segment firms. As discussed in section two, these firms are economically relevant and

are the subject of a sizeable body of research. For example, they serve as the unit of analysis in

studies examining line-of-business diversification (e.g., Lang and Stulz (1994); Berger and Ofek

(1995); Denis, Denis and Sarin (1997); etc.), and numerous studies evaluate these firms disclosure

choices (e.g., Harris (1998); Berger and Hann (2003); Bens, Berger and Monahan (2011); etc.) and

the valuation implications of these choices (e.g., Bens and Monahan (2004), Ettredge, Kwon,

Smith and Zarowin (2005) and Berger and Hann (2007)). We extend this literature by evaluating

the effect that aggregation has on an attribute of firm-level profitability that is of first-order

importance: the ability to communicate bad economic news.

In the next section we formally develop our main hypothesis. In Section 3 we describe our

aggregation proxy in more detail. Section 4 outlines the sample selection process and presents

descriptive statistics. Section 5 formalizes our research design and presents our results. We

conclude in Section 6.

2. Hypothesis Development

If bad economic events impose a lower cost on insiders (e.g., managers, large block

holders, etc.) than minority/non-controlling investors (i.e., outsiders), insiders will exploit their

information advantage and withhold, or delay the release of, information about these events.

Outsiders react to this information problem by price protecting: they reduce the expected value of

managers compensation, they discount securities issued by the firm, etc. This is suboptimal,

5
however, as it leads to deadweight costs. One way of mitigating these costs is for insiders to

commit to provide outsiders with more timely information about bad economic news. 3

Although such a commitment is valuable, perfect timeliness will not be adopted for at least

two reasons. First, outsiders do not want it. Perfect timeliness implies that all bad economic news

is published in a timely manner in the firms financial reports. Although this sort of transparency

increases outsiders ability to monitor insiders actions, it also provides the firms rivals with

valuable information they can use for competitive purposes. In light of this fact, outsiders and

generally accepted accounting principles, GAAP, give managers discretion over when economic

losses are recognized in accounting earnings. 4 Second, the communication of bad economic news

is also imperfect if insiders and outsiders cannot write perfect, complete contracts. Ex post it is

infeasible for outsiders to verify whether insiders provided full information. Moreover, even if

outsiders are able to prove that the manager dissembled, full ex post settling up is not always

possible given horizon problems and the fact that managers have limited liability. This implies that

managers have discretion about what and when they disclose.

One way for managers to exercise their discretion is by aggregating dissimilar activities

into a structure that makes them appear more homogeneous. This can be accomplished via segment

reporting and we refer to this as ex ante aggregation. Aggregation of dissimilar activities allows

managers to hide the sources of their firms earnings from rival firms (e.g., Hayes and Lundholm

3
Ball (2001) and Watts (2003a, b) provide detailed explanations of how such communication arises endogenously
because of governance needs and lending arrangements.
4
A simple example of this phenomenon is a company with a loss-leader strategy in which it uses separate assets to
produce products A and B. A, the loss leader, is sold at a price that equals the incremental cash cost of production.
This implies that when viewed in isolation product A has negative NPV. However, this pricing strategy translates into
higher profits on B via increases in sales volume and sales prices. Full communication and application of accounting
rules might imply that an impairment loss will be recognized on the assets used to produce A at the time the loss-
leader strategy is adopted; however, any economic gains associated with B are only recognized in the future as they
are realized via arms-length exchange transactions. To the extent the loss-leader strategy is expected to generate
economic rents such an accounting choice, and the ancillary disclosures explaining the loss, is against the interests of
the firms shareholders. We discuss the mechanics of impairment measurement per GAAP below.

6
(1996); Harris (1998); etc.). Managers might also aggregate in order to hide information from

outside monitors (e.g., Berger and Hann (2007); Bens, Berger and Monahan (2011)).

The literature cited above evaluates whether unresolved agency problems or proprietary

costs affect the manner in which the firms internal activities are aggregated and reported to

outsiders. We extend this literature by examining how aggregation choices affect firm-level

reported earnings. In particular, we hypothesize that aggregating heterogeneous operations into

homogeneous segments reduces the extent to which reported firm-level earnings communicate bad

economic news in a timely manner. This delayed recognition is important because, as discussed in

Ball (2001) and Watts (2003a, b), it can cause the firms shareholders to make suboptimal

personnel decisions (e.g., retain underperforming executives) and persist with executing

suboptimal investment strategies.

We focus on the implications of ex ante aggregation for managements ability to conduct

ex post offsetting. Higher ex ante aggregation implies a diversification effecti.e., as a business

units activities become more heterogeneous, it becomes more likely that the unit will contain some

unrecognized gain reserves. For managers seeking to maintain a large, stable corporationeither

because they enjoy the quiet life of less operational change (Bertrand and Mullainathan 2003)

or the perquisite consumption that accompanies empire buildingthe offsetting of gain-making

against loss-making activities can fulfill their objectives. Berger and Hann (2007) and Bens, Berger

and Monahan (2011) provide evidence suggesting that strategic segment reporting is correlated

with higher agency costs as captured by inefficient investment. In our setting, the aggregation can

reduce the pressure on management to take costly actions, such as operational restructurings, to

address poor performance.

7
 Gain reserves can also be used to avoid impairment charges. The reason is that they can be

offset against unrecognized losses on other activities in the unit. Absent ex ante aggregation these

losses would be recognized; yet, they are not in this case because they have been aggregated with

other assets providing recoverable cash flows to such an extent that the combined asset group is

not considered to be impaired per U.S. GAAP.

Impairment tests are inherently tied to the aggregation of assets used in the test. U.S. GAAP

provides managers with a great deal of discretion over how this aggregation is done. For example,

tangible fixed assets and identified intangibles subject to amortization are tested at the asset-

group level, with charges recorded when the aggregate carrying amount of the group exceeds its

aggregate undiscounted future cash flows (ASC 360-10-35-17). Managers have discretion over

what to include in an asset group. Although asset group is defined in the ASC glossary as the

lowest level for which identifiable cash flows are largely independent of the cash flows from other

groups of assets and liabilities, practitioners have noted that the definition is challenging to

implement. For example, Nurnberg and Dittmar (1996) state (italics added):

Determining the lowest level of grouping requires considerable judgment. As

groups become broader, more judgment is involved and the opportunity is greater
to combine assets with fair values in excess of carrying amounts with those that are
impaired. Auditors should consider this when evaluating the reasonableness of
groupings.

The standards regarding goodwill asset impairments also afford managers discretion in

aggregation. Goodwill is assigned to a reporting unit and assessed for impairment when the fair

value of the unit falls below its carrying value. Although measuring fair value of non-traded assets

is challenging enough, as described in ASC 350-20-35-37, there is also considerable ambiguity

regarding how to define the unit containing the goodwill (italics added):

Reporting units will vary depending on the level at which performance of the
segment is reviewed, how many businesses the operating segment includes, and the
similarity of those businesses. In other words, a reporting unit could be the same

8
 as an operating segment, which could be the same as a reportable segment, which
could be the same as the entity as a whole.

Practitioner-oriented journals give advice about strategies for allocating goodwill, such as

establish[ing] a strong and well-managed reporting unit to be used as a basis for establishing

goodwill to minimize the impairment problem (Martinson 2002). This passage explicitly

advocates strategic ex ante aggregation in order to avoid future ex post write-offs.

Regulators are aware of these challenges. For example, Scott Taub, former Chief

Accountant at the SEC, discusses the unit-of-account issue (what we refer to as aggregation):

The answers to the unit-of-account issue do not exhibit consistent thinking, nor are
there common principles being applied to reach the answers. Indeed part of the
reason we have so much difficulty resolving unit-of-account issues is that there
hasnt been a real attempt to consider what factors should lead to grouping and at
what levels (Taub 2013).

Taub specifically mentions impairment testing for both tangible and intangible assets as a problem

in this area.

Whether and to what extent aggregation affects the information content of accounting

earnings are thus relevant questions to practitioners. Nonetheless, these issues have received

relatively little attention in the academic literature. Rather, the extant research mainly focuses on

how segments are determined (e.g., Harris (1998) and Berger and Hann (2007)).

A recent academic review paper highlights the importance of aggregation and the relatively

scant amount of research about it. Beyer et al. (2010) provide a comprehensive review of several

facets of the financial reporting environment. One topic they address is the role of conservatism in

financial reporting. Beyer et al. point out the difficulty of accurately measuring it in the presence

of aggregation (italics added):

In our view, obtaining a better understanding of the informational properties of

conservative accounting numbers requires joint consideration of conservatism and
aggregation, another salient feature of accounting. The reason is that ignoring good
news when such news lack verifiability can reduce the informativeness of

9
 accounting reports. This is always true when gains and losses are reported
separately. However, when gains and losses are aggregated, less informative gains
offset more informative losses such that the aggregate report may overall be less
informative when gains are recognized than when gains are not recognized (p.
317).

Beyer et al. describe important components of our research design. We examine whether, in the

presence of such aggregation, accounting reports are less timely in communicating what Beyer et

al. refer to as more informative losses. With the above discussion in mind, we arrive at our main

empirical prediction:

Ha: There is a negative association between aggregation and the timely accounting
recognition of bad economic news.

To test our hypothesis we focus on firms with multiple lines of business. The reason for

this is that both ex ante aggregation and ex post offsetting imply a reduction in the standard

deviation of segment-level profits reported by a firm. Hence, as discussed in section three, the

standard deviation of a multiple-segment firms segment-level profits can be used as the basis for

developing an observable, empirical measure of aggregation.

We acknowledge that our focus on externally reported segments is partially motivated by

our ability to observe and acquire segment-level data. In fact, impairment testing and the

aggregation of heterogeneous operations to avoid such charges can, and likely does, happen at

organizational levels below that of the segment. Yet, without special access to firms internal

general ledgers, it is not practical to observe aggregation at this level. Therefore, we assume that

segment aggregation decisions capture other internal aggregation decisions as well. In and of itself,

however, external segment reporting is a topic of great interest to outsiders evaluating the firm

as evidenced by the large body of academic research we cite in this paper and the large number of

text book sections, practitioner articles, etc. dedicated to the subject (see Palepu, Healy and Peek

2013).

10
 Although our research design prevents us from evaluating aggregation by managers of

single-segment firms, there are advantages to our approach. First, by exploiting segment-level data

published in firms annual financial reports, we are able to develop a firm-level measure of

strategic aggregation. Second, multiple-segment firms play a nontrivial role in the economy. For

example, in terms of market capitalization (price of public equity plus book value of debt) multiple-

segment firms make up approximately 60 percent of the COMPUSTAT population. Third, the

information-production decisions adopted by managers of multiple-segment firms are relevant to

the ongoing debate regarding the valuation implications of line-of-business diversification. 5

Finally, related to the previous point, multiple-segment firms are relatively complex, large and

opaque; and, evidence in Guidry, Leone and Rock (1999), implies that business-unit managers

have incentives to hide business-unit underperformance. Hence, segment managers have both the

motive and opportunity to conduct strategic aggregation.

A related paper is Givoly, Hayn and DSouza (1999), which examines the properties of

reported segment-level revenues and income, including the firm-level determinants of the cross-

sectional variation in the time-series correlation between segment- and industry-level profits, and

the relation between this time-series correlation and the informativeness of segment-level income

numbers. Our research differs from Givoly et al. in two fundamental ways. First, the unit of

analysis in Givoly et al. is the segment; moreover, for each segment they require a fairly long time

series to estimate correlations (on average 14 years per p. 26). Our measure is constructed at the

firm-year level and it can be computed using a single year of data.

5
In particular, evidence provided by Lang and Stulz (1994) and Berger and Ofek (1995) implies that multiple-segment
firms trade at a discount and a number of studies suggest that this discount reflects agency problems that either cause
firms to diversify (e.g., Villalonga (2004)) or result from firms being diversified (e.g., Harris, Kriebel, and Raviv
(1982) and Meyer, Milgrom, and Roberts (1992)). Regardless of whether agency problems are the cause or
consequence of diversification, their existence is partially attributable to management having an information
advantage over outsiders. Hence, the information production decisions of managers of multiple-segment firms are
clearly relevant to the ongoing debate regarding the valuation implications of diversification.

11
 Second, and more importantly, Givoly et al. explore the incremental information content

of segment-level income as a function of their segment-industry correlation measure, not firm-

level information content. To capture the segment-level information content they measure the

incremental r-squared generated by using segment-level income numbers in an earnings-response-

coefficient regression rather than firm-level income (see their Section 5.2). That is, Givoly et al.

treat the information content of firm-level income as a baseline to evaluate the information

contained in segment-level income, unconditionally. We, on the other hand, evaluate the impact

of segment-level aggregation choices on the ability of firm-level income to convey bad economic

news.

Another related paper is Ettredge, Kwon, Smith and Zarowin (2005) which examines the

implication of SFAS 131 for the markets ability to anticipate the firms earnings as captured by

the future earnings response coefficient. They find that for firms disclosing more segments after

SFAS 131 the future earnings response coefficient increased. A maintained assumption in Ettredge

et al. is that their result is consistent with investors benefiting from improved segment-level

disclosures under SFAS 131. Our study compliments Ettredge et al. as we find that segment

reporting decisions likely have firm-level information consequences as well, namely differences

in timely loss recognition, that should also influence investors available information set.

3. Aggregation Proxy

Our aggregation proxy is motivated by the fact that as ex ante aggregation and ex post

offsetting increase, the variance of segment-level profits (measured across segments within a

firms fiscal year) decreases. Hence, for a particular multiple-segment firm in our sample, our

proxy is a decreasing function of the standard deviation of its reported segment-level profits.

12
However, because segment-level profits can vary for reasons other than aggregation, we do not

simply use the inverse of the standard deviation of segment-level profits as our proxy. Rather, we

make several adjustments, which are described below.

To construct our aggregation proxy we begin by identifying all multiple-segment firms in

the COMPUSTAT database. We refer to these observations as actual multiple-segment, AMS,

firm-years. For each AMS firm-year we create a matched pseudo multiple-segment, PMS, firm-

year. This is done by separately matching each of the AMS firms segments to a single-segment

firm in the COMPUSTAT database. In order to obtain a segment-level match we initially identify

all single-segment firms that: (1) have the same fiscal year as the AMS firm and (2) are a member

of the same industry as the relevant segment. 6 Next, we choose from this set the single-segment

firm with reported sales that are closest in magnitude to those of the relevant segment. Finally, for

each AMS firm-year we create a ranked standard deviation ratio, RANK_SRit, which equals the

within-year decile rank (scaled to lie between zero and one inclusive) of the ratio shown below.

STD (PMS _ PM i1t ,..., PMS _ PM ijt ,..., PMS _ PM iNt )

SRit =
STD (AMS _ PM i1t ,..., AMS _ PM ijt ,..., AMS _ PM iNt )
(1)

In equation (1) SRit denotes the standard deviation ratio for an AMS firm (i.e., firm i) that

reports N business segments in fiscal year t, STD() is the standard deviation operator, PMS_PMijt

is the profit margin reported in fiscal year t by pseudo-segment j (i.e., the single-segment firm

matched to segment j of AMS firm i) of PMS firm i, and AMS_PMijt is the profit margin reported

in fiscal year t by segment j of AMS firm i.

6
We match on industry at the most precise level possible using SIC codes. We first determine whether there is a valid
match using the four-digit SIC code. If not, we determine whether there is a valid match using the three-digit code.
Finally, if we still have not found a match, we determine whether there is a valid match using the two-digit code. If
we cannot find a match using either four-digit, three-digit or two-digit SIC code, we exclude the segment and the
corresponding AMS firm from our sample. 63 percent, 22 percent and 15 percent of our matches are made on the basis
of four-digit, three-digit, and two-digit SIC codes, respectively.

13
 Several comments regarding SRit are warranted. First, because we match each of an AMS

firms segments to a single-segment firm of similar size in terms of sales and industry, matched

PMS firms have similar line-of-business compositions as their AMS counterparts. This is

important, as we want to control for natural variation in profits across a firms segments that occurs

for fundamental business reasons. For example, one multiple-segment firm might operate in

industries that are counter-cyclical to one another, hence the standard deviation in profits would

be high compared to a firm that operated in industries that moved together. By benchmarking each

AMS firm with a PMS firm, we capture natural variation. We assume that as the ratio SR rises,

the segment choices made by the AMS firms reflect aggregation done to smooth intrafirm profits

and thus reduces the pressure to communicate bad news via earnings. Of course, the aggregation

may be done for other reasons; and, we discuss controls for these below.

We evaluate the relative standard deviations of profit margins (i.e., segment-level profit

divided by segment-level sales) rather than profits. We do this to further mitigate the effects of

scale differences that are attributable to the fact that we do not have exact sales matches. In

addition, FASB guidance suggests that similar long-term average gross margins are a

determinant in segment aggregation (ASC 280-10-50-11). Third, because the definition of

segment-level profit can vary across AMS firms, we use an algorithm to infer how a particular

AMS firm defines profits for segment reporting. In particular, for each AMS firm-year, we

compare the sum of segment-level profits to various measures of firm-level earnings (see Table 1,

Panel A), and we select the firm-level measure that is closest in magnitude. We then use that

specific firm-level measure as our definition of profit when calculating the profit margins of

pseudo-segments that make up the corresponding PMS firm. In order to mitigate the effect of

extreme observations that can result from using a small number of observations to estimate the

14
standard deviation, as well as the fact that we use a ratio that might be affected by extreme

observations in either the numerator or denominator, we use decile ranks of SR (i.e., RANK_SR)

instead of its raw value.

RANK_SR implicitly assumes that the single-segment portfolio is the correct benchmark

with which to compare the variability of segment-level profits reported by the multiple-segment

firm. Past research questions the appropriateness of this assumption in the diversification discount

literature (Villalonga 2004; Campa and Kedia 2002). This research suggests that the discount

exists because firms self-select their diversification strategies, and these underlying factors driving

the selection are associated with the discount. Therefore, we do not use RANK_SR as our

aggregation proxy; rather, we use the portion of RANK_SR that is orthogonal to differences in

fundamental firm-level variables that differ, on average, between our subsamples of AMS and

PMS firms. These variables include size, book-to-market, leverage, stock returns, and volatility of

stock returns. We refer to the orthogonal component of RANK_SR as R_SR; and, we describe the

model we use to obtain R_SR in Section 4.2.7

There may also be a concern about a mechanical relation between the firms intra-segment-

profit variability and some of the outcome variables we study, such as impairments and

restructuring charges. If a firm is driven to record such charges and they assign these to the segment

level, this could increase the variability of segment profits reported by the multiple-segment firm

in that year. This, in turn, will reduce R_SR (since multiple-segment firms segment-level profits

affect the denominator). Thus, in the cross-section of multiple-segment firms, those with lower

R_SR will record more special charges. On the one hand, we see no problem measuring this effect

contemporaneously with our other phenomena of interest, such as the asymmetric timeliness of

7
We also conduct our tests without adjustments for these factors i.e., we just use the RANK_SR variable. The
untabulated results of these tests lead to identical conclusions as the results shown in the tables.

15
earnings, ATLR. In particular, our objective is to assess whether a more disaggregated segment

structure is associated with greater ATLR. However, to be cautious and to ensure that we are not

documenting a purely mechanical effect, we use the lagged value of R_SR in all of our empirical

tests. 8

We acknowledge that single-segment firms that make up a particular matched PMS firm

may also carry out strategic aggregation. Although this reduces the numerator of SR and, thus,

introduces a negative bias into R_SR, the bias is only relevant if it is associated with the degree of

bad news recognition exhibited by the relevant AMS firm. It is unclear a priori why we should

expect any association to exist between a particular single-segment firms aggregation and a

multiple-segment firms ATLR and nonrecurring charges. Moreover, there is evidence that

managers of multiple-segment firms have more reporting discretion. For example, Bens, Berger

and Monahan (2011) provide evidence that managers of multiple-segment firms behave more

strategically than managers of single-segment firms when making aggregation decisions.

Finally, we note that the aggregation we measure through this focus on the variance of

profit margins within the firm is not equivalent to simply reporting fewer segments. In fact, our

measure R_SR has an insignificant negative Pearson correlation with the number of segments, and

only a modest Spearman correlation of -0.018 (p-value of 0.051). Thus, when R_SR is high the

aggregation we capture is unlikely to be determined by just reporting fewer segments; rather, it is

driven by a narrow dispersion in intrafirm profit margin compared to the industry matched single

segment portfolio.

8
We also conduct our tests using the contemporaneous value of R_SR. The untabulated results of these tests lead to
identical conclusions as the results shown in the tables; in fact, statistical significance levels are almost always larger
using contemporaneously measured R_SR.

16
4. Sample Selection and Descriptive Statistics

4.1 Sample Selection

We begin by creating a firm-level sample (FLS), which consists of data gathered from the

COMPUSTAT annual primary, secondary, tertiary, and full coverage active and research files and

the Center for Research in Security Pricing (CRSP) monthly stock file. To be included in the FLS

a firm-year must have: (1) positive total assets, sales, current and lagged fiscal year-end shares

outstanding, and current fiscal year-end stock price; (2) non-missing long-term debt, net income

before extraordinary items, operating cash flows, equity book value, and diluted earnings per share

including extraordinary items; and, (3) a continuous sequence of stock returns on the CRSP

monthly stock file for the twelve-month period commencing with the fourth month after the end

of the previous fiscal year.

Next, we create a segment-level sample (SLS) by gathering data from the COMPUSTAT

segment files. We delete segment observations without positive segment-level sales

(COMPUSTAT data item SALE), for which all of the available segment-level income variables

(COMPUSTAT data items OPS, OIBD, or NI) are missing, for which there is no available

segment-level SIC code (COMPUSTAT data items SSIC1 or SSIBC1), or that have a profit margin

(i.e., the ratio of segment-level income to sales) with an absolute value that is greater than 1.00.

Third, we create a sample of actual multiple-segment (AMS) firm-years by combining

observations from the SLS with the FLS. This sample consists of those observations for which at

least two segments can be matched to a single firm-year in the FLS. Matches are made on the basis

of SPC Permanent Number (COMPUSTAT data item GVKEY) and fiscal-year-end date

(FYEAR). A multiple-segment firm-year is excluded from the AMS sample if: (1) its stock price

at the beginning of fiscal year t is less than $2.00 or (2) its market value of equity at the beginning

17
of fiscal year t is less than $5M or (3) the sum of segment-level sales for the segments successfully

matched to it are not within one percent of its firm-level sales.

Finally, we identify single-segment firm-years in the FLS that are successfully matched

(on the basis of GVKEY and FYEAR) to zero or one segment in the SLS and that have firm-level

profit margin with an absolute value not greater than 1.00. These single-segment firms are used to

form pseudo multiple-segment (PMS) firms via the matching process described in section three.

4.2 Descriptive Statistics for the Standard Deviation Ratio

In Panel B of Table 1 we provide descriptive statistics for the lagged version of SR, which

is the average standard deviation ratio (as described in equation (1)) in years t-2 and t-1. As

discussed above, our measure of aggregation is based on the within-year decile rank (scaled to lie

between zero and one) of SR and, thus, we provide separate descriptive statistics of SR for each

decile. We also show the number of observations in each decile (i.e., N). The reason that N varies

across deciles is that we remove extreme values of other variables after assigning observations to

deciles.

Several comments regarding Panel B are warranted. First, many of the AMS firm-years in

our sample have values of SR that are less than one; for example, the median value of SR for AMS

firm-years in decile three is 0.72. Second, observations in decile n often have values of SR that are

lower than values of SR corresponding to observations in decile n-1. For example, the median

value of SR for decile 7 is 2.64, which is less than the maximum value of SR for decile 6 (3.10).

Transitivity is imperfect because we use within-year rankings to assign SR to a particular decile;

and, it suggests that SR contains a nontrivial temporal component. However, because we use

within-year rankings to form R_SR this temporal component is irrelevant. Hence, our results are

not attributable to variation in omitted macro factors that are correlated with both SR and

18
accounting recognition of bad news. 9 Finally, some values of SR are extreme. For example, the

mean of SR for decile 10 is 667.83. This suggests that the use of ranks is a sensible way for us to

arrive at a proxy with a high signal-to-noise ratio.

In Panel C of Table 1 we compare characteristics of the 11,464 AMS firm-years to

characteristics of their matched PMS counterparts, and we evaluate whether differences in these

characteristics are related to RANK_SR. For each variable DIF_X listed in the first column of

Panel C, we calculate a value for each AMS firm-year (AMS_Xit) and a value for the corresponding

PMS firm-year (PMS_Xit) and then we calculate DIF_Xit = AMS_Xit - PMS_Xit. For example, to

calculate DIF_MVEit we first determine the equity market value of AMS firm i in year t. Second,

we calculate PMS_MVEit by summing the year t equity market values of the single-segment firms

matched to the segments of AMS firm i. 10 Finally, we compute DIF_MVEit by subtracting

PMS_MVEit from AMS_MVEit.

The results shown in Panel C demonstrate that our matching algorithm does not yield a set

of PMS firms that are identical to their AMS counterparts. For example, the mean of DIF_MVEit

is $376 and its standard deviation (inter-quartile range) is $12,343 ($987). However, none of the

differences are strongly associated with RANK_SR. This suggests that the potential for

confounding effects arising from imperfect matching of PMS firms to AMS firms is low.

9
Segment reporting changed during the middle of our sample period with the adoption of SFAS 131. Because we
construct R_SR by using ranks within a given year for each ranking we have, the regime is constant; hence this change
in reporting should not affect our main tests. In Sections 5.3 and 6.1 we utilize the SFAS 131 adoption by identifying
firms that change their segment reporting. This is a useful way to validate our metric. When we split our main set of
tests into two samples, pre and post-131, we do not observe significant differences for the population as a whole; but
again, this is not surprising given the within year ranking process we utilize.
10
When the Xit is a ratio (e.g., book-to-market ratio), we set Xit for the PMS firm equal to the sales-weighted average
of the numerator of the single-segment firms matched to the segments of AMS firm i in year t divided by the sales-
weighted average of the denominator of the single-segment firms. When Xit is a function of stock return (e.g., annual
stock return, RETit), we calculate stock return for PMS firm i by taking a sales-weighted average of the separate returns
for the single-segment firms matched to the segments of AMS firm i in year t.

19
 Nonetheless, to mitigate the risk that our results are driven by systemic differences between

AMS and PMS firms, we orthogonalize RANK_SR against these fundamentals (which are also

ranked into deciles). 11 We also orthogonalize RANK_SR from several additional variables that are

measured solely at the AMS firm-level. These variables could conceivably be related to the

characteristics of diversified firms and the accounting recognition of bad news. Specifically, we

use the model below:

RANK _ SRit 1 = 0 + 1 EX _ VALUE it + 2 RELATE it 3 NUM _ SEGit

0.657 -0.020 -0.004 -0.001
(27.21) (-10.63) (-2.05) (-0.64)
+ 4 CAPINTit + 5 DIF _ MVFit + 6 DIF _ BTM it 7 DIF _ LEVit (2)
-0.007 0.001 -0.003 0.005
(-3.51) (0.81) (-1.71) (3.26)
8 DIF _ Rit + 9 DIF _ RETit + it 1
0.002 -0.009
(1.70) (-6.82)

The dependent variable is the ranking of SR. As defined above, DIF_X for each independent

variable is the difference between the value of X for AMS firm and the value of X for the

corresponding PMS firm. We also add the excess value of diversification (EX_VALit), a measure

of segment relatedness (RELATEit), the number of segments (NUM_SEGit) and capital intensity

(CAP_INTit). (See Table 2 for variable definitions. 12) Finally, we use the rank of the regression

residual, it, which we refer to as R_SR, as our main treatment variable. 13

11
Even though we choose the single segment firm with the closest value in sales to the relevant segment of the AMS
firm, sometimes the differences can be quite significant. When we restrict the match on the sum of the single segment
sales to be 300% of total sales of the multiple-segment firm, our sample size declines from 11,464 to 10,950. Our
conclusions from using this restricted sample are unchanged.
12
EXVAL is drawn from Bens and Monahan (2004) who document an association between the excess value of
diversification and aggregation. RELATE, NUMSEG, and CAPINT are drawn from Givoly et al. Those authors also
included a relative segment size variable and an international operations measure. The former is not applicable in our
model at the firm level; the latter is problematic as international segment reporting changed midway through our
sample via SFAS 131 (Hope and Thomas (2008)). See Table 3 of Givoly et al. for more details of their approach.
13
In particular, we first sort all values of it-1 for year t into deciles and create the variable DR_it-1, which equals the
DR _ it 1 1
decile rank of it-1 for AMS firm i in year t; and, R _ SRit 1 = .
9

20
5. Test of Relation between Strategic Aggregation and Accounting Informativeness

5.1 Tests of Impairments, Special Charges, and Restructurings

In Panel A of Table 2 we provide descriptive statistics for the variables used in estimating

model (3) below:

D _ CHARGEit = 0 + 1 R _ SRit 1 + 2 RETit + 3 ROAit + 5 I _ ROAit + 7 SALE it

+ 8 I _ SALE it + 9 BTM it + 9 BTM it + 10 LEVit + 11 SIZEit (3)
+ 12 GDP _ GRit + it

The dependent variable, D_CHARGEit, is an indicator that equals one (zero) if AMS firm i

reported (did not report) a special charge in year t. As of 2001, COMPUSTAT has specific fields

related to asset impairments and restructuring charges. Thus, for the years 2001 through 2010, we

use the presence of these charges as separate dependent variables. Prior to that time COMPUSTAT

used the more generic special items to record a myriad of accruals, including not only

impairments and restructurings, but also other charges that were unusual.

Our main hypothesis variable is R_SR, which is increasing in the degree of aggregation

conducted by the managers of the AMS firm. Aggregation allows managers to define asset groups

broadly, which, via a diversification effect, increases the likelihood that the asset group has future

cash flows that exceed its carrying value. Aggregation also allows managers to hide losses from

outsiders, as poor-performing and high-performing product lines are combined. In this case

managers will be less likely to divest projects that have negative net present values. This implies

a lower rate of both impairments and other charges such as restructurings or other accruals that

will be picked up by special items in COMPUSTAT. Hence, we predict that there is a negative

association between R_SR and all three of these special charges.

21
 Our control variables capture firm, industry, and macroeconomic fundamentals that have

been shown to predict special charges (see Francis, Hanna and Vincent (1996); and Bens and

Johnston (2009)). These variables include firm-level stock return (RET); firm-level and industry-

level return on assets in the current period, as well as the lagged period (ROA, and I_ROA);

the annual percentage change in firm-level and industry-level sales (SALE and I_SALE);

beginning of period book-to-market ratio (BTM) and the change in the ratio (BTM); beginning

of period firm leverage (LEV); beginning of period firm size (SIZE) and, to control for macro-

economic shocks, the growth in U.S. gross domestic product (GDP_GR). 14 Note, as discussed in

section four, we use the lagged value of R_SR.

In Table 3, Panel A we present the estimates obtained from the Probit model. In column

(1) we show results with the probability of asset impairment as the dependent variable. This

includes both tangible and intangible asset impairments. In the second column, the more generic

indicator for the presence of negative special items serves as the dependent variable. The major

advantage of this specification is that it allows us to study a longer time period in the database.

The third column uses the occurrence of a restructuring charge as the dependent variable.

Results in the first column relate to the relation between R_SR and the probability of an

asset impairment. The marginal effect related to R_SR is 0.031. This implies that, holding all

other variables constant at their mean values, moving from the lowest to highest decile of R_SR is

associated with a 3.05 percent reduction in the likelihood of an impairment loss. Our control

variables generally have the correct sign and are statistically significant.

Our results hold over the longer sample period, but using the less well defined special

items designation from COMPUSTAT (middle column). Finally, in the right hand column we see

14
Given the dependent variable is a function of impairment losses we add impairment losses back to net income before
extraordinary items when calculating ROA.

22
even stronger results for the specifically recorded restructuring charges. This is consistent with our

prediction that aggregation serves not only to make impairments less likely, it also provides

management slack such that they can avoid real operational actions like restructurings.

In Panel B of Table 3 we re-specify the model as a Tobit, since each of these charges can

be measured as a continuous variable censored at zero (we record positive special items as zero

and use the absolute value of negative items). Our results are robust to this specification.

Overall, the results suggest that aggregation reduces the likelihood of an asset impairment,

special item, or restructuring charge. These are important accruals for communicating bad news to

investors about underlying asset values. In the next section we examine more general properties

of earnings behavior in both the face of bad news and the presence of aggregation.

5.2 Tests of the Earnings-return Relation

Our analysis of the effect of strategic aggregation on the earnings-return relation is based

on the regression described in Basu (1997) and shown in equation (4) below.

DEPS it = 0 + 1 N _ Rit + 2 RETit + 3 N _ Rit RETit + 4 R _ SRit 1

+ 5 R _ SRit 1 N _ Rit + 6 R _ SRit 1 RETit + 7 R _ SRit 1 N _ Rit RETit
+ BTM it ( 8 + 9 N _ Rit + 10 RETit + 11 N _ Rit RETit ) (4)
+ LEVit ( 12 + 13 N _ Rit + 14 RETit + 15 N _ Rit RETit )
+ SIZEit ( 16 + 17 N _ Rit + 18 RETit + 19 N _ Rit RETit ) + it

In equation (4), DEPSit denotes diluted earnings per share after extraordinary items reported by

AMS firm i in fiscal year t deflated by beginning period share price. RETit is the stock return for

AMS firm i for the twelve-month period commencing with the fourth month after the end of fiscal

year t-1, N_Rit is an indicator variable that equals one (zero) if RETit is negative (non-negative),

and it is an error term.

A maintained assumption underlying equation (4) is that stock returns reflect economic

news; hence, if 3 is significantly greater than zero, bad news is reflected in earnings in a more

23
timely fashion than good news (i.e., there is asymmetric timely loss recognition or ATLR). Our

main hypothesis is that there is a negative association between aggregation and ATLR; hence, we

alter equation (4) by allowing the intercept and slope coefficients to vary with R_SR and we predict

a negative coefficient for 7, the interaction between RET, N_R and R_SR. This prediction follows

the logic that as more heterogeneous activities are aggregated together, the accounting systems

ability to communicate bad news is reduced. We demonstrate this in the previous sub-section with

the direct examination of specific bad news accruals. The model (4) regression above is a more

comprehensive view of earnings, where management information is revealed in more subtle ways

(e.g., increased operating provisions) compared to the stark special charges. In Panel A of Table 4

we present descriptive statistics for the variables used in estimating equation (4); and, in Panel B

of Table 4, we present correlations.

In columns one, two and three of Table 5 we present regression estimates taken from the

regression shown in Basu (1997), a version of equation (4) in which we allow the coefficients to

vary with R_SR, and finally the full version of equation (4) in which we allow the coefficients to

vary with R_SR as well as other determinants of ATLR identified in past literature (e.g., Khan and

Watts 2009). These other determinants are: book-to-market (BTM), leverage (LEV), and firm size

(SIZE). Below each estimated coefficient we show the estimated Huber-White standard error (firm

and year clusters). We begin by discussing the results in column (1). For our sample, good news

is not reflected in contemporaneous earnings (i.e., the coefficient on RET is insignificant) but bad

news is (i.e., the coefficient on N_RRET equals 0.138 and is significant at the 0.01 level).

Moreover, consistent with our main hypothesis, as shown in column (2), there is a strong negative

relation between ATLR and R_SR (i.e., the coefficient on R_SRN_R RET equals 0.064 and

is significant at the 0.05 level). Hence, firm-years in the highest R_SR decile report earnings that

24
exhibit roughly 62.4% as much ATLR as firm-years in the lowest R_SR decile (i.e., (0.170-

0.064)0.170 = 62.4%). Furthermore, as shown in column (3), controlling for BTM, LEV, and

SIZE does not affect the tenor of our results. 15 Finally, note that this affect is not solely driven by

the non-recurring items and their relation with R_SR as identified in Table 3. When we remove

special items from DEPS in equation (4) our conclusions are unchanged.

5.3 SFAS 131 and Asymmetric Timely Loss Recognition

SFAS 131, which is effective for fiscal years beginning after December 15, 1998,

compelled managers to move away from using fairly broad definitions of industry when

reporting segment results. SFAS 131 introduced the management approach, which requires that

a firms external reporting structure reflects its internal reporting structure. As discussed in Berger

and Hann (2003), one purpose of adopting the management approach was to reduce discretion

about segment definition and, thus, induce more segmentation.

We use the adoption of SFAS 131 as a means of measuring changes in aggregation. In

particular, we evaluate whether firms that exhibited more segments after adopting SFAS 131

exhibited greater ATLR. As discussed in Section 2, reporting fewer segments is only one way of

strategically aggregating diverse operations. Managers could choose to report multiple segments,

but match the privately observable cash flow generating units in such a way that performance is

smoothed across the externally reported segments, which, in turn implies lower informativeness.

Nonetheless, for this test we make the assumption that managers who report more segments after

15
Inclusion of these variables is partially redundant, as we have purged R_SR of its variation with the constructs with
respect to their differences across single and multiple-segment firms. However, it is still possible that within the
multiple-segment sample both R_SR and the asymmetric timeliness of earnings might vary with these factors. In
addition, we note that the increase in explanatory power for the model that adds R_SR is quite low. Still, the statistical
significance of the coefficient is high and suggests that allowing the bad news coefficient to vary with R_SR provides
a better understanding of the conditions under which such news translates into earnings.

25
adopting SFAS 131 are aggregating less. We evaluate the six-year period surrounding the adoption

of SFAS 131. The model we estimate is shown in equation (5) below. 16

DEPS it = 0 + 1 N _ Rit + 2 RETit + 3 N _ Rit RETit + 4 POSTit

+ 5 POSTit N _ Rit + 6 POSTit RETit + 7 POSTit N _ Rit RETit
+ 8 HS i + 9 HS i N _ Rit + 10 HS i RETit + 11 HS i N _ Rit RETit (5)
+ 12 POSTit HS i + 13 POSTit HS i N _ Rit + 14 POSTit HS i RETit
+ 15 POSTit HS i N _ Rit RETit + it

In equation (7), POSTit is an indicator variable that equals one (zero) for the fiscal years 1998

through 2000 (1995 through 1997) and HSii.e., hidden segmentsequals the difference between

the average number of segments reported by firm i during the post-period and the average number

reported in the pre-period. (If this difference is negative, we set HSi to zero. 17) To address the

differences between single and multiple-segment firms we include a single segment dummy

variable, SS, which takes the value of one for any firm that reported as a single segment, either

before or after SFAS 131, zero otherwise. Like our hidden-segment variable, HS, SS is interacted

with returns (RET), the negative return dummy (N_R) and POST.

In this test, we no longer restrict our sample to firms that were multiple-segment throughout

the entire panel. 18 The reason for this is that we no longer use R_SR as our aggregation proxy.

Rather, we now focus on the firms that reported more segments in the post-adoption period vis--

16
Although one might expect the effects to be concentrated around the adoption year (i.e., a two-year window with
one year pre and post), we do not observe significant results when we use this time period. Possible explanations for
this include that there is an adaptation process in the application of SFAS 131 and how it relates to the communication
of bad news. Also, note that for our predicted result to be evident, we need a sufficient number of firms from the post
period and with previously hidden segments and with negative returns. So there are power issues involved. We believe
that using three years before and after: (1) addresses these issues and (2) is a tight enough window around the reporting
change.
17
This effects 9.28 percent of the sample. We obtain similar results, untabulated but available upon request, when we
do not replace negative values of HSi with zero.
18
Note that all firms in this sample reported multiple-segments in at least one year; that is, there are no firms in this
sample that are single-segment throughout the entire sample-period.

26
vis the pre-adoption period; and, we predict that ATLR will increase for these firmsi.e., we

predict 15 > 0.

There are two advantages to these tests. First, by focusing on 15 we are essentially taking

a differences-in-differences approach. In particular, we compare the temporal change in ATLR for

those firms that increased the number of reported segments to the temporal change in ATLR for

those firms that did not. Second, SFAS 131 is an exogenous reporting change at the firm level.

We show the results of estimating equation (5) in Table 6. Column (1) includes the variable

POST and its interaction with RET and N_R; we observe that average ATLR was higher in the

post-period relative to the pre-period. In Column (2), we add HS. Interestingly, in the pre-period

firms with hidden segments (i.e., HSi > 0) exhibited lower ATLR as 11 is negative. However, in

the post-period when these firms disaggregate their data, their ATLR is similar to the remainder

of the sample as 15 is positive.

The results shown in Table 6 are robust to the inclusion of the Khan and Watts (2009)

controls (Column (3)). We cannot be sure that the newly reported segments are not simply the

result of firm expansion. Therefore, we measure the change in total assets across the two periods

as well as the cash spent on acquisitions during the POST period. We term the sum of these

amounts NEWINV, and include it as an additional control (with the appropriate interactions) in

Column (4). Finally, in Column (5) we include the single segment dummy, SS. As demonstrated

in Column (5), our conclusions regarding the effects of hidden segments are unchanged; 15 is still

positive and significant.

Overall, these results buttress the conclusions we draw from the results shown in Tables 3

and 5i.e., that greater aggregation implies less ATLR. In particular, they suggest that when

27
SFAS 131 caused firms to provide more disaggregated data, accounting earnings reflected bad

economic news in a more timely fashion.

5.4 Validity Test of R_SR with Data from Berger and Hann

While we believe our construct R_SR has intuitive appeal as a measure of aggregation, it

is still a proxy. Ideally we would measure the underlying operating structure and construct a

measure of how this was aggregated; Bens, Berger and Monahan (2011) take this approach, but

the data they use are controlled by the U.S. Census Bureau and cannot be shared. We also

attempted to collect the complete list of SIC codes that a firm operates in, as used by Bens and

Monahan (2004) and Berger and Hann (2003); those authors collected this information from

Standard & Poors. 19 Unfortunately, in discussion with S&P we were told that they no longer

produce this material in either paper or electronic formats. 20

We are able to conduct a useful validity check with a data set kindly provided by Berger

and Hann (2003; 2007). These authors use restated data following SFAS 131 adoption, manually

collected from the financial statement notes, to identify a change in reporting structure. This

includes not only firms moving from a single segment to multiple segments; it also includes

multiple-segment firms changing the number and operational make-up of their previously reported

segments.

Our goal is to validate our disaggregation measure, so we examine how it changes amongst

the sample of firms that Berger and Hann identify as having revealed different segments. There is

an overlap of 331 firms with our sample. We measure the raw SR measure (i.e., the ratio of the

standard deviation of the matched single segment profit margins to the standard deviation of the

19
See p. 699 of Bens and Monahan (2004) where they refer to the Standard & Poors Register of Corporations,
Directors and Executives.
20
We also explored other possible data sources, but found that promised disaggregated data was either just externally
reported numbers (Thomson Reuters), or inconsistently measured from year to year (Lexis Nexis).

28
actual segment level profit margins), as well as our orthoganilized, ranked measure, R_SR. We

examine the average value for these 331 firms for the three years before and the three years after

SFAS 131 adoption.

The average raw value of SR falls for these firms from 5.7 to 3.0 following the display of

new segments post SFAS 131. This difference is statistically significant at the 1% level. The mean

value of R_SR falls from 0.53 to 0.47, which is significant at the 5% level. 21

The other firms in our sample that were not identified as changing segments by Berger and

Hann experienced an average increase of SR from 9.82 to 19.50, and a decrease in R_SR from

0.52 to 0.51. Neither of these changes is significantly different from zero. The average difference

in difference across these two groups is marginally significant (one tailed p-value of <0.08 for SR

and <0.11 for R_SR). Overall, this analysis provides some comfort that our aggregation measures

shifts in a predictable direction with an independent data set that identifies enhancements in

segment disclosures.

6. Conclusion

Investors demand information that helps them identify value destruction so they can

promptly exercise their ownership and control rights. Financial reports are a key source of this

information and their quality is improved when they reflect bad economic news in a timely manner.

Summary financial reports, by necessity, reflect an aggregation of firm activities. Yet there is

relatively scant evidence regarding the association between firms aggregation decisions and the

properties of earnings. We argue that aggregation of heterogeneous activities can be measured by

comparing the standard deviation of profit margins within a multiple-segment firm with a similar

21
The economic magnitude of the change in R_SR is difficult to interpret since this measure is based on a ranking
and has been purged of the firm fundamental effects from model (2).

29
measure at a matched portfolio sample of single segment firms. Because strategically aggregating

such activities reduces variations in profit margins within the firm, we believe our proxy captures

non-neutral aggregation decisions.

We show that aggregation has a negative association with the likelihood of reporting an

impairment loss as well as restructuring charges and other special items, which are key accounting

sources of information about bad economic news. We also show that higher aggregation is

associated with lower asymmetric timely loss recognition, which is an important accounting

attribute. Finally, following SFAS 131 those firms that revealed previously aggregated operations

experienced an increase in timely loss recognition compared to the firms in the sample that did not

reveal new segments.

Our study is relevant as we provide initial evidence regarding the extent to which

aggregation influences the informativeness of accounting numbers about bad economic news. This

evidence is important because it helps academics and practitioners understand better the sources

of ATLR, the tradeoffs that managers face when determining aggregation levels, and the

consequences of those choices.

30
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33
 Table 1
SR Measure Statistics
Panel A: Inferred Segment Level Earnings Measure (N=11,464)
X = Added Back
DEP_AM INT TAX SPEC Frequency
NIBE 6.08%
NIBE + DEP_AM X 7.34%
NIBE + INT X 5.91%
NIBE + TAX X 9.99%
NIBE + SPEC X 5.16%
NIBE + DEP_AM + INT X X 7.80%
NIBE + DEP_AM + TAX X X 9.15%
NIBE + DEP_AM + SPEC X X 7.58%
NIBE + INT + TAX X X 20.73%
NIBE + INT + SPEC X X 6.16%
NIBE + TAX + SPEC X X 9.16%
NIBE + DEP_AM + INT + TAX X X X 11.03%
NIBE + DEP_AM + INT + SPEC X X X 8.69%
NIBE + DEP_AM + TAX + SPEC X X X 9.65%
NIBE + INT + TAX + SPEC X X X 21.67%
NIBE + DEP_AM + INT + TAX + SPEC X X X X 13.62%
Grand Total Including Ties: 159.71%
SR Measure Statistics
Panel B: SR Statistics by Decile Rank (N=11,464)
Decile Rank of SR Mean Std Min Q1 Median Q3 Max N
1 0.21 0.09 0.00 0.14 0.22 0.28 0.41 1,138
2 0.47 0.08 0.27 0.41 0.47 0.54 0.71 1,144
3 0.73 0.11 0.41 0.65 0.72 0.80 1.06 1,150
4 1.03 0.15 0.57 0.91 1.02 1.13 1.46 1,150
5 1.41 0.24 0.91 1.22 1.39 1.57 2.13 1,145
6 1.93 0.37 1.22 1.65 1.88 2.17 3.10 1,152
7 2.76 0.68 1.61 2.28 2.64 3.15 5.35 1,152
8 4.37 1.37 2.09 3.38 4.09 5.11 10.46 1,146
9 8.74 4.13 3.12 5.72 7.72 10.66 32.36 1,147
10 667.83 12,142 6.09 18.26 32.30 85.11 395,363 1,140
Full Sample 68.58 3,833 0.00 0.71 1.60 4.09 395,363 11,464
SR Measure Statistics
Panel C: Comparison of AMS firms to PMS firms (N=11,464)
Correlation W/ RANK_SR:
Mean Std Min P10 Q1 Median Q3 P90 Max Pearson Spearman
DIF_MVE ($M) $ 376 $ 12,343 $ (466,738) $ (2,212) $ (523) $ (37) $ 464 $ 3,071 $ 204,360 -0.037 *** -0.054 ***
DIF_MVF ($M) $ 594 $ 14,053 $ (466,571) $ (2,593) $ (626) $ (44) $ 582 $ 3,995 $ 306,970 -0.032 *** -0.061 ***
EXVAL 20% 173% -100% -73% -52% -18% 33% 122% 5040% -0.082 *** -0.155 ***
DIF_ASSET ($M) $ 612 $ 14,399 $ (466,925) $ (1,943) $ (387) $ 18 $ 858 $ 4,541 $ 285,362 -0.022 ** -0.080 ***
DIF_SALE ($M) $ 1,068 $ 10,303 $ (195,942) $ (596) $ (101) $ 13 $ 469 $ 2,945 $ 395,824 -0.002 -0.005
DIF_BTM 0.03 2.73 -10.66 -0.68 -0.31 -0.03 0.23 0.63 240.95 0.014 0.036 ***
DIF_LEV -0.01 0.21 -2.53 -0.25 -0.12 0.00 0.12 0.25 0.78 0.020 ** 0.032 ***
DIF_(BVD/MVE) -0.35 5.34 -489.76 -1.18 -0.37 -0.04 0.18 0.63 31.60 0.013 0.034 ***
DIF_RET -0.07 0.94 -46.82 -0.65 -0.28 -0.01 0.25 0.56 3.72 -0.005 -0.004
DIF_RET -0.03 0.08 -1.23 -0.12 -0.07 -0.03 0.00 0.04 0.66 -0.057 *** -0.069 ***

34
Panel A of Table 1 lists the different earnings measures used to compute pseudo-segment profit
margins. Frequency denotes the frequency that a particular measure is used. When one or more of
the add-back items (DEP_AM, INT, TAX, SPEC) is zero, it creates a tie between two or more
earnings measures. Therefore, the sum of frequencies is greater than one. NIBE is income before
extra-ordinary items (COMPUSTAT variable IB), DEP_AM is depreciation and amortization
expense (COMPUSTAT variable DP), INT is interest and related expenses (COMPUSTAT
variable XINT), TAX is total tax expense (COMPUSTAT variable TXT), and SPEC is special
items (COMPUSTAT variable SPI).

Panel B of Table 1 contains descriptive statistics for the standard deviation ratio (i.e., SRit-1) by
decile. Deciles are formed on the basis of annual rankings of SRit-1.

Panel C of Table 1 contains descriptive statistics regarding differences between characteristics of

AMS firms and characteristics of PMS firms. It also contains correlations (Pearson product
moment and Spearman rank order) between R_SRit-1 and each of these differences. The sample
period spans 1987-2010. The sample consists of all available actual multiple-segment (i.e., AMS)
firm-years. Firm-years with beginning stock price less than $2 or market value of equity less than
$5M or with a segment that has a return on sales with an absolute value that is greater than 100
percent are deleted. ***, **, and * denote that a correlation is statistically different from zero with
a p-value (assuming a two-sided test) of 0.01, 0.05 and 0.10, respectively.

In this table we use the lagged SR measure, labeled SR. SR is the average of the standard deviation
ratios for the previous two years, which is defined below.

STD (PMS _ PM i1t ,..., PMS _ PM ijt ,..., PMS _ PM iNt )

SRit =
STD (AMS _ PM i1t ,..., AMS _ PM ijt ,..., AMS _ PM iNt )

In the above equation SRit denotes the standard deviation ratio for an AMS firm (i.e., firm i) that
reports N business segments in fiscal year t, STD() is the standard deviation operator, PMS_PMijt
is the profit margin reported in fiscal year t by pseudo-segment j (i.e., the single-segment firm
matched to segment j of AMS firm i) of PMS firm i, and AMS_PMijt is the profit margin reported
in fiscal year t by segment j of AMS firm i.

DIF_X = AMS_X - PMS_X, AMS_X denotes the value of variable X for a particular AMS firm
and PMS_X is the value of the variable X for the corresponding PMS firm.

MVE denotes equity market value (COMPUSTAT variable PRCC_F multiplied by CSHO). MVF
denotes firm market value and equals equity market value plus the book value of long-term and
short-term debt (COMPUSTAT data item DLTT plus DLC). When short-term debt is missing, we
replace its value with zero. EXVAL is the excess value of diversification as shown in the equation
below (note that negative values are indicative of a greater diversification discount):

35


AMS _ MVFit
EXVALit =
N PMS _ MVFijt
PMS _ SALE AMS _ SALEijt
j =1 ijt

ASSET denotes total assets (COMPUSTAT variable AT). SALE is total revenues (COMPUSTAT
variable SALE). BTM is the book-to-market ratio and equals equity book value (COMPUSTAT
variable CEQ) divided by equity market value. LEV equals the ratio of debt book value to total
assets, while BVD/MVE equals debt book value divided by equity market value. RET is the stock
return for the 12 month period commencing on the fourth month of fiscal year t. RET is the
standard deviation of monthly stock returns for fiscal year t.

We calculate values of the variable X for a particular PMS firm by aggregating across the single-
segment firms that make up the PMS firm. For example, to calculate PMS_MVE we sum the equity
market values of the single-segment firms that are matched to the segments of the corresponding
AMS firm. If X is a ratio (e.g., the book-to-market ratio, BTM), we set X for the PMS firm equal
to the sales-weighted average of the numerator of the single-segment firms matched to the
segments of the corresponding AMS firm divided by the sales-weighted average of the
denominator of the single-segment firms matched to the segments of the corresponding AMS firm.
If X is a function of stock return (e.g., annual stock return, RET), we calculate stock return for
PMS firm i by taking a sales-weighted average of the separate returns for the single-segment firms
matched to the segments of corresponding AMS firm.

36
 Table 2
Descriptive Statistics
Panel A: Descriptive Statistics for Variables Employed in the Asset Impairment Tests (N=10,799)
Mean Std Min P10 Q1 Median Q3 P90 Max
D_WD (N=4,946) 0.236 0.425 0 0 0 0 0 1 1
D_SPEC 0.389 0.487 0 0 0 0 1 1 1
D_REST (N=4,946) 0.303 0.460 0 0 0 0 1 1 1
RET 0.128 0.449 -0.959 -0.374 -0.142 0.087 0.334 0.647 3.922
ROA -0.005 0.056 -1.409 -0.055 -0.019 0.000 0.016 0.041 0.353
I_ROA -0.013 0.025 -0.178 -0.043 -0.021 -0.008 0.001 0.009 0.124
SALE 0.085 0.188 -0.777 -0.110 -0.008 0.070 0.161 0.293 1.305
I_SALE 0.068 0.094 -0.445 -0.044 0.021 0.069 0.117 0.172 0.592
BTM 0.674 0.559 0.000 0.229 0.358 0.561 0.826 1.204 11.440
SIZE 6.431 2.047 0.524 3.684 4.967 6.473 7.899 9.079 12.579
LEV 0.244 0.168 0.000 0.005 0.107 0.246 0.357 0.458 0.899
GDP_GR 0.020 0.016 -0.049 0.006 0.012 0.022 0.032 0.037 0.041
WD (N=4,946) -0.006 0.025 -0.38 -0.01 0 0 0 0 0
SPEC -0.010 0.028 -0.40 -0.03 -0.01 0 0 0 0
REST (N=4,946) -0.002 0.006 -0.13 -0.01 0 0 0 0 0
Descriptive Statistics
Panel B: Correlation Statistics for Variables Employed in the Asset Impairment Tests (N=10,779)
R_SR D_WD D_SPEC D_REST RET ROA I_ROA SALE I_SALE GDP_GR
R_SR -0.045 -0.034 -0.090 -0.030 -0.014 0.007 0.029 -0.001 -0.013
0.001 0.001 <.0001 0.002 0.143 0.481 0.003 0.952 0.191
D_WD -0.045 0.405 0.175 -0.089 0.023 -0.063 -0.117 -0.071 -0.101
0.001 <.0001 <.0001 <.0001 0.106 <.0001 <.0001 <.0001 <.0001
D_SPEC -0.034 0.405 0.493 -0.059 -0.003 -0.010 -0.072 -0.045 -0.114
0.001 <.0001 <.0001 <.0001 0.723 0.279 <.0001 <.0001 <.0001
D_REST -0.090 0.175 0.493 -0.020 -0.058 -0.004 -0.157 -0.103 -0.041
<.0001 <.0001 <.0001 0.163 <.0001 0.790 <.0001 <.0001 0.004
RET -0.030 -0.107 -0.084 -0.038 0.114 0.039 0.076 -0.034 0.200
0.002 <.0001 <.0001 0.007 <.0001 <.0001 <.0001 0.001 <.0001
ROA -0.005 0.028 0.007 -0.042 0.146 0.237 0.265 0.081 -0.019
0.629 0.046 0.466 0.003 <.0001 <.0001 <.0001 <.0001 0.053
I_ROA 0.010 -0.062 -0.002 0.018 0.031 0.270 0.138 0.320 0.077
0.291 <.0001 0.873 0.212 0.002 <.0001 <.0001 <.0001 <.0001
SALE 0.030 -0.116 -0.089 -0.175 0.110 0.296 0.159 0.339 0.071
0.002 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001
I_SALE 0.011 -0.067 -0.026 -0.091 0.012 0.101 0.340 0.357 0.116
0.265 <.0001 0.006 <.0001 0.223 <.0001 <.0001 <.0001 <.0001
GDP_GR -0.009 -0.088 -0.115 -0.041 0.136 0.007 0.090 0.095 0.165
0.350 <.0001 <.0001 0.004 <.0001 0.449 <.0001 <.0001 <.0001

Panel A of Table 2 displays descriptive statistics for variables used in the asset impairment tests
presented on Table 3 and Table 9. The sample consists of all available actual multiple-segment
(i.e., AMS) firm-years during the time period spanning 1987 through 2010 with non-missing
special items. Firm-years with beginning stock price less than $2 or market value of equity less
than $5M or with a segment that has a return on sales with an absolute value that is greater than
100 percent are deleted.

37
Panel B of Table 2 reports the correlation structure of these variables (Pearson product moment
are shown above the diagonal and Spearman rank order are shown below the diagonal).

D_WD takes a value of one when there is a tangible or intangible asset write-off (COMPUSTAT
variables WDP or GDWLIP), else zero. D_SPEC takes a value of one when there are income
decreasing special items (COMPUSTAT variable SPI), else zero. D_REST takes a value of one
when there is an income reducing restructuring charge (COMPUSTAT variable RCP), else zero.
Beginning in 2001 COMPUSTAT specifically coded items as asset impairments and restructuring
charges, therefore D_WD and D_REST have a smaller sample size. RET is the stock return for the
12 month period commencing on the fourth month of fiscal year t. _ROA is the change in ROA
from t-1 to t. ROA is income before extraordinary items for year t (COMPUSTAT variables IB)
divided by total assets for year t-1(COMPUSTAT variables AT). I__ROA is the change in
I_ROA from t-1 to t. I_ROA is the average of ROA by 2 digit SIC code for year t. _SALE is the
percent change in SALE from t-1 to t. SALE is total revenues (COMPUSTAT variable SALE)
from year t. I__SALE is the percent change in I_SALE from t-1 to t. I_SALE is the average of
SALE by 2 digit SIC code for year t. BTM is the book-to-market ratio and equals equity book
value (COMPUSTAT variable CEQ) divided by equity market value. LEV equals the ratio of debt
book value to total assets. SIZE is the natural log of the equity market value (COMPUSTAT
variable PRCC_F multiplied by CSHO). GDP_GR is the percent change in gross domestic product
between the last quarter of the fiscal year and the quarter preceding the fiscal year. WD is income
decreasing tangible or intangible asset write-offs (COMPUSTAT variables WDP or GDWLIP),
divided by total assets for year t-1. SPEC is income decreasing special items (COMPUSTAT
variable SPI), divided by total assets for year t-1. REST is income decreasing restructuring charges
(COMPUSTAT variable RCP), divided by total assets for year t-1.

In this table we use a ranked, lagged and orthogonalized SR measure, labeled R_SR. We begin by
calculating RANK_SR, which is the within sample-year decile ranking (scaled to lie between zero
and one) of the average standard deviation ratio over the previous two years, which is defined
below.

STD (PMS _ PM i1t ,..., PMS _ PM ijt ,..., PMS _ PM iNt )

SRit =
STD (AMS _ PM i1t ,..., AMS _ PM ijt ,..., AMS _ PM iNt )

In the above equation SRit denotes the standard deviation ratio for an AMS firm (i.e., firm i) that
reports N business segments in fiscal year t, STD() is the standard deviation operator, PMS_PMijt
is the profit margin reported in fiscal year t by pseudo-segment j (i.e., the single-segment firm
matched to segment j of AMS firm i) of PMS firm i, and AMS_PMijt is the profit margin reported
in fiscal year t by segment j of AMS firm i.

Next, we determine R_SR by obtaining the residual from the regression shown below.

RANK _ SRit 1 = 0 + 1 EX _ VALUEit + 2 RELATEit + 3 NUM _ SEGit + 4 CAPINTit

+ 5 DIF _ MVFit + 6 DIF _ BTM it + 7 DIF _ LEVit + 8 DIF _ RETit
+ 9 DIF _ RETit + it 1

38
RELATE equals 1 minus the percent of segments operating in unique 2-digit SIC codes.
NUM_SEG, is calculated as the number of potential pair-wise combinations of segments. CAPINT
is the total net value of property, plant and equipment (COMPUSTAT variable PPENT) divided
by total assets. The remaining regressors in the above equation are defined in Table 1.

39
 Table 3
Panlel A : Asset Impairment Probability Model (PROBIT ANALYSIS)
D_CHARGE it = 0 + 1 R_SR it-1 + 2 RET it + 3 ROA it + 5 I_ROA it + 7 SALE it + 8 I_SALE it +
9 BTM it + 10 BTM it + 11 LEV it + 12 SIZE it + 13 GDP_GR it + it
DEPENDENT VARIABLE: D_CHARGE =

Prediction D_WD D_SPEC D_REST

Intercept 0 ? -1.4745 *** -1.0546 *** -1.4452 ***
(0.1187) (0.0728) (0.1150)
R_SR it-1 1 - -0.1123 * -0.0792 ** -0.2429 ***
(0.0644) (0.0397) (0.0620)
RET it 2 - -0.1957 *** -0.1227 *** -0.0270
(0.0494) (0.0320) (0.0468)
ROA it 3 - 2.5578 *** 1.5416 *** 1.1948 ***
(0.3574) (0.2473) (0.3417)
I_ROA it 4 - -3.8206 *** -7.4608 *** -3.7749 ***
0.7907 (0.5648) (0.7685)
SALE it 5 - -0.9062 *** -0.4188 *** -1.1793 ***
(0.1294) (0.0747) (0.1254)
I_SALE it 6 - 0.0897 0.5268 *** -0.0922
(0.2431) (0.1519) (0.2354)
BTM it 7 + 0.1635 *** 0.0496 0.0438
(0.0553) (0.0345) (0.0532)
BTM it 8 + 0.2865 *** 0.1375 *** 0.0722
(0.0521) (0.0338) (0.0517)
LEV it 9 + 0.0926 *** 0.1094 *** 0.1538 ***
(0.0118) (0.0071) (0.0115)
SIZE it 10 ? 0.1569 0.1371 * -0.1913 *
(0.1179) (0.0743) (0.1144)
GDP_GR it 11 - -1.9637 -4.7812 *** 1.3346
(1.4319) (0.8498) (1.4084)
Number of Observations 4,946 10,779 4,946
Psuedo R-Square 0.055 0.059 0.079
*** Significant at the 1% level, ** Significant at the 5% level, * Significant at the 10% level

In this table we report estimates taken from Probit models analyzing the likelihood of three
different charge-off measures. The sample period spans 1987-2010. The primary sample consists
of all available actual multiple-segment (i.e., AMS) firm-years. Firm-years with beginning stock
price less than $2 or market value of equity less than $5M or with a segment that has a return on
sales with an absolute value that is greater than 100 percent are deleted. Significance levels are
based on a two-tailed distribution. In this table we use a ranked, lagged and orthogonalized SR
measure, labeled R_SR. See the Table 2 notes for a description of R_SR.

D_WD takes a value of one when there is a tangible or intangible asset write-off (COMPUSTAT
variables WDP or GDWLIP), else zero. D_SPEC takes a value of one when there are income
decreasing special items (COMPUSTAT variable SPI), else zero. D_REST takes a value of one
when there is an income reducing restructuring charge (COMPUSTAT variable RCP), else zero.

40
Beginning in 2001 COMPUSTAT specifically coded items as asset impairments and restructuring
charges, therefore D_WD and D_REST have a smaller sample size. RET is the stock return for the
12 month period commencing on the fourth month of fiscal year t. ROA is the change in ROA
from t-1 to t. ROA is income before extraordinary items for year t (COMPUSTAT variables IB)
divided by total assets for year t-1(COMPUSTAT variables AT). I__ROA is the change in
I_ROA from t-1 to t. I_ROA is the average of ROA by 2 digit SIC code for year t. SALE is the
percent change in SALE from t-1 to t. SALE is total revenues (COMPUSTAT variable SALE)
from year t. I__SALE is the percent change in I_SALE from t-1 to t. I_SALE is the average of
SALE by 2 digit SIC code for year t. BTM is the change in BTM from t-1 to t. BTM is the book-
to-market ratio and equals equity book value (COMPUSTAT variable CEQ) divided by equity
market value. LEV equals the ratio of debt book value to total assets. SIZE is the natural log of the
equity market value (COMPUSTAT variable PRCC_F multiplied by CSHO). GDP_GR is the
percent change in gross domestic product between the last quarter of the fiscal year and the quarter
preceding the fiscal year.

41
 Table 3
Panlel B : Asset Impairment Magnitude Model (TOBIT ANALYSIS)
CHARGE it = 0 + 1 R_SR it-1 + 2 RET it + 3 ROA it + 5 I_ROA it + 7 SALE it + 8 I_SALE it +
9 BTM it + 10 BTM it + 11 LEV it + 12 SIZE it + 13 GDP_GR it + it
DEPENDENT VARIABLE: CHARGE =

Prediction WD SPEC REST

Intercept 0 ? 0.0079 *** 0.0122 *** 0.0020 ***
(0.0020) (0.0015) (0.0005)
R_SR it-1 1 - -0.0026 ** -0.0021 *** -0.0009 ***
(0.0011) (0.0008) (0.0003)
RET it 2 - -0.0058 *** -0.0082 *** -0.0005 **
(0.0008) (0.0007) (0.0002)
ROA it 3 - 0.1272 *** 0.0970 *** 0.0048 ***
(0.0058) (0.0050) (0.0015)
I_ROA it 4 - -0.1155 *** -0.1955 *** -0.0336 ***
0.0136 (0.0118) (0.0035)
SALE it 5 - -0.0220 *** -0.0146 *** -0.0048 ***
(0.0021) (0.0016) (0.0005)
I_SALE it 6 - 0.0110 *** 0.0113 *** 0.0001
(0.0041) (0.0032) (0.0010)
BTM it 7 + 0.0035 *** 0.0004 0.0000
(0.0009) (0.0007) (0.0002)
BTM it 8 + 0.0032 *** -0.0009 -0.0005 **
(0.0009) (0.0007) (0.0002)
LEV it 9 + 0.0000 0.0003 *** 0.0001 ***
(0.0002) (0.0001) (0.0000)
SIZE it 10 ? -0.0029 -0.0064 *** -0.0018 ***
(0.0020) (0.0016) (0.0005)
GDP_GR it 11 - -0.1057 *** -0.0361 ** 0.0174 ***
(0.0247) (0.0180) (0.0063)

Number of Observations 4,946 10,779 4,946

Adj. R-Square from OLS Version 0.136 0.078 0.057
*** Significant at the 1% level, ** Significant at the 5% level, * Significant at the 10% level

In this table we report estimates taken from Tobit models analyzing the magnitude of three
different charge-off measures. The sample period spans 1987-2010. The primary sample consists
of all available actual multiple-segment (i.e., AMS) firm-years. Firm-years with beginning stock
price less than $2 or market value of equity less than $5M or with a segment that has a return on
sales with an absolute value that is greater than 100 percent are deleted. Significance levels are
based on a two-tailed distribution. In this table we use a ranked, lagged and orthogonalized SR
measure, labeled R_SR. See the Table 21 notes for a description of R_SR.

WD is income decreasing tangible or intangible asset write-offs (COMPUSTAT variables WDP

or GDWLIP), divided by total assets for year t-1. SPEC is income decreasing special items
(COMPUSTAT variable SPI), divided by total assets for year t-1. REST is income decreasing

42
restructuring charges (COMPUSTAT variable RCP), divided by total assets for year t-1.
Beginning in 2001 COMPUSTAT specifically coded items as asset impairments and restructuring
charges, therefore WD and REST have a smaller sample size. RET is the stock return for the 12
month period commencing on the fourth month of fiscal year t. ROA is the change in ROA from
t-1 to t. ROA is income before extraordinary items for year t (COMPUSTAT variables IB) divided
by total assets for year t-1(COMPUSTAT variables AT). I__ROA is the change in I_ROA from
t-1 to t. I_ROA is the average of ROA by 2 digit SIC code for year t. SALE is the percent change
in SALE from t-1 to t. SALE is total revenues (COMPUSTAT variable SALE) from year t.
I__SALE is the percent change in I_SALE from t-1 to t. I_SALE is the average of SALE by 2
digit SIC code for year t. BTM is the change in BTM from t-1 to t. BTM is the book-to-market
ratio and equals equity book value (COMPUSTAT variable CEQ) divided by equity market value.
LEV equals the ratio of debt book value to total assets. SIZE is the natural log of the equity market
value (COMPUSTAT variable PRCC_F multiplied by CSHO). GDP_GR is the percent change in
gross domestic product between the last quarter of the fiscal year and the quarter preceding the
fiscal year.

43
 Table 4
Descriptive Statistics
Panel A: Descriptive Statistics for Variables Employed in the Asymmetric Timeliness Regressions (N=11,464)
Mean Std Min P10 Q1 Median Q3 P90 Max
DEPS 0.039 0.085 -0.821 -0.041 0.020 0.052 0.077 0.109 0.582
RET 0.126 0.456 -0.968 -0.385 -0.148 0.085 0.335 0.652 3.922
N_R 0.40 0.49 0 0 0 0 1 1 1
BTM 0.669 0.560 0.000 0.222 0.353 0.555 0.820 1.200 11.440
LEV 0.242 0.170 0.000 0.004 0.102 0.243 0.357 0.460 0.899
SIZE 6.390 2.058 0.524 3.629 4.894 6.437 7.865 9.063 12.579
Descriptive Statistics
Panel B: Correlation Statistics for Variables Employed in the Asymmetric Timeliness Regressions (N=11,464)
R_SR DEPS RET BTM LEV SIZE
R_SR -0.029 -0.035 0.031 -0.028 -0.162
0.002 0.000 0.001 0.003 <.0001
DEPS -0.041 0.234 -0.178 -0.057 0.156
<.0001 <.0001 <.0001 <.0001 <.0001
RET -0.037 0.317 -0.248 -0.038 0.146
<.0001 <.0001 <.0001 <.0001 <.0001
BTM 0.017 0.006 -0.264 0.046 -0.411
0.066 0.542 <.0001 <.0001 <.0001
LEV -0.032 0.024 -0.036 0.059 0.060
0.001 0.010 0.000 <.0001 <.0001
SIZE -0.159 0.093 0.183 -0.454 0.096
<.0001 <.0001 <.0001 <.0001 <.0001

Panel A of Table 4 reports descriptive statistics for variables used in the regressions shown in
Tables 5, 6 and 8. In Panel B we report the correlation structure of these variables (Pearson product
moment are shown above the diagonal and Spearman rank order are shown below the diagonal).
The sample period spans 1987-2010. The primary sample consists of all available actual multiple-
segment (i.e., AMS) firm-years. Firm-years with beginning stock price less than $2 or market value
of equity less than $5M or with a segment that has a return on sales with an absolute value that is
greater than 100 percent are deleted. In this table we use a ranked, lagged and orthogonalized SR
measure, labeled R_SR. See the Table 1 notes for a description of R_SR.

DEPS is diluted earnings per share excluding ordinary items at time t (COMPUSTAT variable
EPSFX) divided by the stock price at the end of year t-1 (COMPUSTAT variable PRCC_F). RET
is the stock return for the 12 month period commencing on the fourth month of fiscal year t. N_R
is an indicator variable that takes on a value of one when RET < 0; else zero. BTM is the book-to-
market ratio and equals equity book value (COMPUSTAT variable CEQ) divided by equity market
value. LEV equals the ratio of debt book value to total assets. SIZE is the natural log of the equity
market value (COMPUSTAT variable PRCC_F multiplied by CSHO).

44
 Table 5
Basu Model-based Analyses
DEPS it = 0 + 1 N_R it + 2 RET it + 3 N_R it *RET it + 4 R_SR it-1 + 5 R_SR it-1 *N_R it + 6 R_SR it-1 *RET it +
7 R_SR it-1 *N_R it *RET it + BTM it *( 8 + 9 N_R it + 10 RET it + 11 N_R it *RET it )
LEV it *( 12 + 13 N_R it + 14 RET it + 15 N_R it *RET it ) + SIZE it *( 16 + 17 N_R it + 18 RET it + 19 N_R it *RET it ) + it
Prediction Column 1 Column 2 Column 3
Intercept 0 ? 0.0559 *** 0.0591 *** 0.0518 ***
(0.0033) (0.0052) (0.0056)
N_R it 1 ? -0.0058 0.0007 -0.0062
(0.0036) (0.0066) (0.0073)
RET it 2 + 0.0014 -0.0046 -0.0092
(0.0097) (0.0173) (0.0148)
N_R it * RET it 3 + 0.1375 *** 0.1700 *** 0.1271 ***
(0.0151) (0.0231) (0.0212)
R_SR it-1 4 ? -0.0064 -0.0037
(0.0062) (0.0049)
R_SR it-1 * N_R it 5 ? -0.0127 -0.0130 *
(0.0091) (0.0073)
R_SR it-1 * RET it 6 ? 0.0123 0.0069
(0.0208) (0.0151)
R_SR it-1 * N_R it * RET it 7 - -0.0636 ** -0.0635 **
(0.0278) (0.0243)
BTM it 8 ? 0.0007
(0.0009)
BTM it * N_R it 9 ? 0.0002
(0.0010)
BTM it * RET it 10 ? 0.0013
(0.0025)
BTM it * N_R it * RET it 11 + 0.0212 ***
(0.0034)
LEV it 12 ? 0.0006
(0.0005)
LEV it * N_R it 13 ? -0.0006
(0.0010)
LEV it * RET it 14 ? 0.0003
(0.0014)
LEV it * N_R it * RET it 15 + -0.0004
(0.0025)
SIZE it 16 ? 0.0001
(0.0009)
SIZE it * N_R it 17 ? 0.0020 *
(0.0011)
SIZE it * RET it 18 ? 0.0000
(0.0022)
SIZE it * N_R it * RET it 19 - -0.0117 ***
(0.0028)
Number of Observations 11,464 11,464 11,464
Adjusted R-Square 0.105 0.106 0.132
*** Significant at the 1% level, ** Significant at the 5% level, * Significant at the 10% level

This table shows the results obtained from estimating variations of the regression shown in
equation (4). The sample consists of all available actual multiple-segment (i.e., AMS) firm-years

45
with the requisite dependent and independent variables. Firm-years with beginning stock price less
than $2 or market value of equity less than $5M or with a segment that has a return on sales with
an absolute value that is greater than 100 percent are deleted. The estimated coefficients are taken
from panel regressions and the Huber-White standard errors (firm and year clusters) are reported
in parentheses. Significance levels are based on a two-tailed distribution. In this table we use a
ranked, lagged and orthogonalized SR measure, labeled R_SR. See the Table 2 notes for a
description of R_SR.

DEPS is diluted earnings per share excluding ordinary items at time t (COMPUSTAT variable
EPSFX) divided by the stock price at the end of year t-1 (COMPUSTAT variable PRCC_F). RET
is the stock return for the 12 month period commencing on the fourth month of fiscal year t. N_R
is an indicator variable that takes on a value of one when RET < 0; else zero. BTM is the book-to-
market ratio and equals equity book value (COMPUSTAT variable CEQ) divided by equity market
value. LEV equals the ratio of debt book value to total assets. SIZE is the natural log of the equity
market value (COMPUSTAT variable PRCC_F multiplied by CSHO).

46
 Table 6
Basu Model-based SFAS131 Analyses
DEPS it = 0 + 1 N_R it + 2 RET it + 3 N_R it *RET it + 4 POST it + 5 POST it *N_R it + 6 POST it *RET it + 7 POST it *N_R it *RET it + 8 HS it + 9 HS it *N_R it +
10 HS it *RET it + 11 HS it *N_R it *RET it + 12 POST it *HS it + 13 POST it *HS it *N_R it + 14 POST it *HS it *RET it + 15 POST it *HS it *N_R it *RET it +
SIZE it *( 16 + 17 N_R it + 18 RET it + 19 N_R it *RET it + 20 POST it + 21 POST it *N_R it + 22 POST it *RET it + 23 POST it *N_R it *RET it ) +
BTM it *( 24 + 25 N_R it + 26 RET it + 27 N_R it *RET it + 28 POST it + 29 POST it *N_R it + 30 POST it *RET it + 31 POST it *N_R it *RET it ) +
LEV it *( 32 + 33 N_R it + 34 RET it + 35 N_R it *RET it + 36 POST it + 37 POST it *N_R it + 38 POST it *RET it + 39 POST it *N_R it *RET it ) + it

Prediction Column 1 Column 2 Column 3 Column 4 Column 5

Intercept 0 ? 0.0462 *** 0.0456 *** 0.0431 *** 0.0323 *** 0.0536 ***
(0.0060) (0.0050) (0.0033) (0.0070) (0.0028)
N_R it 1 ? -0.0180 ** -0.0209 * -0.0123 -0.0236 -0.0109
(0.0089) (0.0085) (0.0068) (0.0220) (0.0059)
RET it 2 + 0.0031 -0.0002 0.0096 0.0065 0.0298 **
(0.0191) (0.0206) (0.0102) (0.0398) (0.0104)
N_R it * RET it 3 + 0.1457 *** 0.1563 *** 0.1366 *** 0.1638 * 0.1183 **
(0.0294) (0.0284) (0.0257) (0.0686) (0.0382)
POST it 4 ? -0.0065 -0.0064 -0.0047 -0.0261 0.0156 *
(0.0133) (0.0135) (0.0098) (0.0317) (0.0065)
POST it * N_R it 5 ? 0.0383 ** 0.0411 ** 0.0348 *** 0.0316 0.0135
(0.0118) (0.0125) (0.0079) (0.0376) (0.0101)
POST it * RET it 6 ? -0.0141 -0.0129 -0.0189 -0.0249 -0.0722 **
(0.0198) (0.0214) (0.0125) (0.0399) (0.0263)
POST it * N_R it * RET it 7 + 0.0813 ** 0.0763 ** 0.1002 *** 0.0861 0.1474 **
(0.0244) (0.0235) (0.0238) (0.0676) (0.0456)
HS it 8 ? 0.0005 0.0009 0.0002 0.0002
(0.0018) (0.0015) (0.0021) (0.0018)
HS it * N_R it 9 ? 0.0061 0.0048 0.0045 0.0079
(0.0037) (0.0044) (0.0029) (0.0042)
HS it * RET it 10 ? 0.0047 0.0023 0.0042 0.0054
(0.0032) (0.0021) (0.0031) (0.0034)
HS it * N_R it * RET it 11 - -0.0258 *** -0.0225 ** -0.0205 *** -0.0280 ***
(0.0034) (0.0063) (0.0051) (0.0045)
POST it * HS it 12 ? -0.0003 0.0017 -0.0006 0.0001
(0.0024) (0.0019) (0.0026) (0.0022)
POST it * HS it * N_R it 13 ? -0.0017 -0.0056 -0.0016 -0.0032
(0.0048) (0.0055) (0.0046) (0.0052)
POST it * HS it * RET it 14 ? -0.0044 -0.0042 -0.0051 -0.0048
(0.0055) (0.0038) (0.0047) (0.0056)
POST it * HS it * N_R it * RET it 15 + 0.0145 *** 0.0142 ** 0.0124 * 0.0169 ***
(0.0020) (0.0054) (0.0055) (0.0034)
CONTROLS 16-39 ? EXCLUDED EXCLUDED SIZE, BTM & LEV AT & AQC SINGLE_SEG

Number of Observations 12,947 12,947 12,947 12,947 12,947

Adjusted R-Square 0.093 0.095 0.155 0.116 0.100
*** Significant at the 1% level, ** Significant at the 5% level, * Significant at the 10% level

This table shows the results obtained from estimating variations of the regression shown in
equation (5). The sample consists of all available firm-years with the requisite dependent and
independent variables. Firm-years with beginning stock price less than $2 or market value of equity
less than $5M are deleted. The estimated coefficients are taken from panel regressions and the
Huber-White standard errors (firm and year clusters) are reported in parentheses. Significance
levels are based on a two-tailed distribution.

DEPS is diluted earnings per share excluding ordinary items at time t (COMPUSTAT variable
EPSFX) divided by the stock price at the end of year t-1 (COMPUSTAT variable PRCC_F). RET
is the stock return for the 12 month period commencing on the fourth month of fiscal year t. N_R
is an indicator variable that takes on a value of one when RET < 0; else zero. BTM is the book-to-
market ratio and equals equity book value (COMPUSTAT variable CEQ) divided by equity market

47
value. LEV equals the ratio of debt book value to total assets. SIZE is the natural log of the equity
market value (COMPUSTAT variable PRCC_F multiplied by CSHO).
POST is an indicator variable that equals one (zero) for the fiscal years 1998 through 2000 (1995
through 1997). HS equals the average number of segments reported by firm i during the post-
period less the average number of segments reported in the pre-period. (If this difference is
negative, we set HS to zero). AT is the change in total assets, which is calculated as the
difference between post-period and pre-period average assets. AQC is the cash spent on
acquisitions during the POST period (COMPUSTAT variable AQC). SINGLE_SEG equals one
if the firm reported as a single-segment firm either before or after the implementation of SFAS
131; else zero.

48