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International Review of Financial Analysis 16 (2007) 496 – 507

Proportionate consolidation versus the equity method: Additional evidence on the association with bond ratings ☆
Mark P. Bauman ⁎
College of Business Administration, University of Northern Iowa, Cedar Falls, IA 50614, United States Available online 23 June 2007

Abstract From a financial analysis perspective, proportionate consolidation of significant influence equity investments is often presumed to provide more useful information than equity method accounting. Surprisingly, Kothavala [Kothavala, K., 2003, Proportional consolidation versus the equity method: A risk measurement perspective on reporting interests in joint ventures, Journal of Accounting and Public Policy 22, 517–538.] finds that financial statement measures based on the equity method are more relevant for bond ratings than are similar measures based on proportionate consolidation. This study provides additional evidence regarding this issue. Using a sample of manufacturing firms with significant influence equity investments accounted for under U.S. GAAP, the results indicate that pro forma proportionately consolidated financial statements have greater relevance than equity method statements for explaining bond ratings. © 2007 Elsevier Inc. All rights reserved.
JEL classification: G10; M41 Keywords: Bond ratings; Accounting methods

1. Introduction The accounting for significant influence equity investments is interesting due to the diversity observed in practice. For example, while the IASB recommends and Canada requires

☆ I thank Chris Bauman, Ken Shaw, an anonymous reviewer, and the editor for their helpful comments and suggestions. I also thank Donald Cram for generously providing SAS code for a logit-based likelihood ratio test. ⁎ Tel.: +1 319 273 4323; fax: +1 319 273 2922. E-mail address: mark.bauman@uni.edu.

1057-5219/$ - see front matter © 2007 Elsevier Inc. All rights reserved. doi:10.1016/j.irfa.2007.06.005

Section 4 concludes. 2. Dragun. & Fried. There is a presumption that significant influence exists with ownership interests of 20% or more. the investor combines on a line-byline basis its accounts with its pro rata share of the investee's accounts. 1999. Bauman / International Review of Financial Analysis 16 (2007) 496–507 497 proportionate consolidation for joint venture investments. Unlike Stoltzfus and Epps (2005). a significant influence equity investment is reflected in the investor's financial statements as single lines in the balance sheet and income statement. Under proportionate consolidation. Sondhi. 1 . In the current study. 1999) and the differences between financial statements prepared under proportionate consolidation versus the equity method (see Kothavala (2003) for a detailed summary). proportionate consolidation provides a more comprehensive view of the investor's operations and financial condition. Section 2 presents the research design. Research has examined various aspects of credit analysis (e. Laitinen. financial statement measures As described in Accounting Principles Board (APB) Opinion No.P. the results are not altered when guarantees of investee obligations are considered. First. 2003). King. using the same variable definitions. 1971). I estimate the models employed by Kothavala (2003).” Graham. 2004.S. Davis and Largay (1999. 281) find “no substantive justification for continued use of the equity method…due to the method's intrinsically limited informational characteristics. investors must use the equity method for investments in common stock that provide “significant influence over operating and financial policies of an investee even though the investor holds 50% or less of the voting stock” (APB 18. White. These differing results are most likely due to homogeneity of the sample firms in the present study. & Lazear. 18 (APB. This presentation of net amounts is criticized as a means of facilitating off-balance sheet activities and potentially hindering effective financial analysis (e.. 1993.g. Not all studies find in favor of proportionate consolidation. Stickney & Brown. Stoltzfus and Epps (2005) find that financial statements prepared under proportionate consolidation are more strongly associated with bond risk premiums than equity method statements only for firms that guarantee the debt of joint venture investments. Overall. ¶17). these results add to the ongoing debate regarding the usefulness of financial statements prepared under alternative methods of accounting for significant influence equity investments. U. Section 3 describes the data and results. Using a sample of Canadian firms.g. Carleton. and Morrill (2003) find that financial statements prepared under proportionate consolidation provide better predictions of future profitability than pro forma statements prepared under the equity method. I use a sample of U. p. Accordingly. The remainder of the paper proceeds as follows. In contrast to Kothavala (2003). Kothavala (2003) finds that equity method statements are more relevant for bond ratings than are proportionately consolidated statements.M. even majority-owned subsidiaries. manufacturing firms to examine further the relative information content of proportionately consolidated versus equity method financial statement amounts for explaining bond ratings. Bierman (1992) argues that proportionate consolidation is superior and should be used for all material equity investments. GAAP requires the equity method of accounting.S.1 Under the equity method. Research design The empirical analysis proceeds in three steps. Penman. In particular. the results indicate that proportionately consolidated financial statements have greater relevance than equity method statements for explaining bond ratings..

one must recognize that the ROA term is equal to the product of PM and asset turnover (ATO. and VR is revenue volatility (calculated as the standard deviation of total revenues scaled by the book value of common equity). the marginal effect of PM on RATING is appropriately measured as α3·ATO + α5 and β3·ATO + β5 in Eqs. Bauman / International Review of Financial Analysis 16 (2007) 496–507 based on amounts determined under equity method (E) and proportionate consolidation (P) accounting are separately regressed against bond ratings: ðEÞ RATINGit ¼ a0 þ a1 TAEit þ a2 LEVEit þ a3 ROAEit þ a4 SRAEit þ a5 PMEit þ a6 VREit þ eit ðPÞ RATINGit ¼ b0 þ b1 TAPit þ b2 LEVPit þ b3 ROAPit þ b4 SRAPit þ b5 PMPit þ b6 VRPit þ eit . This difference is due to the lack of +/− modifiers in Compustat for bond ratings of CC and C. however. as credit risk should be decreasing in firm size and profitability. and VR are expected to be positive.P. there are no firms with ratings below CCC in the current sample. However. (1) and (2). However. there is no clear prediction for the coefficient on the PM term itself. Thus. For consistency. (1) and (2). the market value of equity is also substituted for book value of equity in the leverage term (LEV). The next step of the empirical analysis involves two modifications to Eqs. and the test of relative information content from Biddle. Further. With respect to profit margin. Second. the models do not include guarantees of investee obligations made by investors. Eqs. First. A rating of “AAA” is assigned a value of 1 and a rating of “D” is assigned a value of 22. ROA is return on assets (calculated as net income divided by ending total assets). the coefficient estimates in Kothavala (2003) are negative. Kothavala (2003) states that the coefficient on PM should be negative (i. 2 . Kothavala's finding that equity method statements are more relevant for bond ratings than are proportionately consolidated statements may be due to her sample not including many firms that provide such guarantees. profit margin inversely related to risk). As acknowledged by Kothavala (2003). I substitute the market value of equity for book value of equity in the VR term.e. SRA is the standard deviation of ROA. many sample firms RATING ranges from 1 to 27 in Kothavala (2003). The coefficients on TA and ROA are expected to be negative. Seow. Conversely.2 The independent variables are measured as follows: TA is the natural logarithm of total assets. ð1Þ ð2Þ where RATING is the Standard & Poor's long-term issuer credit rating. As VR is designed to measure the volatility of (scaled) revenues. Given ROA represents the interaction between PM and ATO. A likely cause of this unexpected result is a small denominator problem associated with scaling by book value of equity. SRA. In the current study.. Thus. While the marginal effect of PM on RATING should be negative. the coefficients on LEV. Stoltzfus and Epps (2005) find that the existence of guarantees affects the relative explanatory power (for bond risk premiums) of proportionately consolidated versus equity method statements. respectively. the coefficient should be positive. the focus is on relative explanatory power of financial statement measures based on the equity method versus proportionate consolidation. (1) and (2) are estimated via OLS regression. non-nested models. it is unlikely that bond raters ignore these contingent liabilities.498 M. where ATO = total revenues ÷ total assets). specific details on guarantees are often not available in financial statements. LEV is total liabilities divided by the book value of common equity. PM is profit margin (net income divided by total revenues). However. and Siegel (1995) (“BBS”) is used to compare the two competing. as credit risk is increasing in leverage and volatility.

4 The test is a logit-based version of the Vuong (1989) test. non-zero amounts for “Equity in Earnings” (Compustat item #55).P. As the existence of guarantees increases the level of risk. Bauman / International Review of Financial Analysis 16 (2007) 496–507 499 disclose guarantees related to investee obligations. allowing for more valid comparisons of ratio values. the final sample consists of 39 firms and 173 firm-year observations from 1997– 2001. . GUAR. the existence of guarantees enters the revised models in the form of an indicator variable.g. designed to statistically compare the log likelihood statistics of non-nested models. 5 SEC regulations require detailed footnote disclosure only when one of three specific materiality thresholds is met. Kennedy. The sample is similar in size to that used by Kothavala (2003) — 40 firms and 156 firmyear observations from 1995–2000.S. etc. Data and results 3.4 3. such that the ratings represent equal intervals on a scale of creditworthiness. Eqs.) cannot be accurately quantified. formal guarantee of a credit facility) can be identified. Limiting the sample to manufacturers increases the degree of homogeneity among firms. there is a problem using the OLS estimator with bond ratings as the dependent variable.5 An example of pro forma proportionate consolidation of an equity method investee is provided in the Appendix. Accordingly. To address the possibility of misspecification. 3 Recall that GUAR represents guarantees made by the investor company with respect to obligations of the investee. manufacturing firm (SIC code between 2000 and 3999). it is expected that GUAR will have a positive coefficient. OLS assumes that bond ratings are measured on an interval scale. and (4) provide footnote disclosures in sufficient detail to permit pro forma proportionate consolidation of equity method investees. any difference in explanatory power from estimating Eqs. However. (1′) and (2′) are estimated using an ordered logit model. 1998).g. a firm must (1) be a calendar year-end U. bond ratings convey ordinal information (Kaplan & Urwitz. (1995) is then used to compare the two competing models. (2) have non-missing. others (e. the credit risk of the investor is increasing in the presence of such guarantees. Data and descriptive statistics To be included in the sample. The logit-based test of relative information content from Hillegeist et al.3 If the inclusion of GUAR increases the information content of one model relative to the other. 1979. set equal to 1 if the firm discloses some form of guarantee (and equal to 0 otherwise): ðEÞ RATINGit ¼ a0 þ a1 TAEit þ a2 LEVMEit þ a3 ROAEit þ a4 SRAEit þ a5 PMEit þ a6 VRMEit þ a7 GUAR þ eit ðPÞ RATINGit ¼ b0 þ b1 TAPit þ b2 LEVMPit þ b3 ROAPit þ b4 SRAPit þ b5 PMPit þ b6 VRMPit þ b7 GUAR þ eit . Thus. deficiency agreements. After deleting observations with negative book values.. (3) have Standard & Poor's issuer debt ratings reported on Compustat (item #280). VRM is the standard deviation of total revenues scaled by the market value of common equity.. Finally. (1′) and (2′) may be affected. ð10 Þ ð20 Þ where LEVM is total liabilities divided by the market value of common equity.1. Although the precise dollar amount of some commitments (e. take-or-pay contracts.M. and all other variables are as defined above.

indicating that the substitution of market value of equity for book value is effective in addressing the small denominator problem.55 0.301 Median 9.967 0. and GUAR = 1 if a guarantee of investee obligations is disclosed (= 0 otherwise). the amounts based on the equity method are significantly different from those based on proportionate consolidation.033 1.01 b0. Table 1 presents descriptive statistics for the variables appearing in the models.75 0.698 0.309 0 S.000 8.06 0. the suppression of investee sales amounts under the equity method results in greater reported profit margin (PM). 6 .01 b0.514 1. VRM is the standard deviation of total revenues scaled by market value of common equity. total assets (TA) and leverage (LEV) are greater under proportionate consolidation due the suppression of asset and liability amounts under the equity method. SRA is the standard deviation of ROA.039 0.033 0.619 1.33 8.07 1.374 8. Under the equity method.6 For all variables.32 1.542 8. In contrast.045 0.01 b0.464 0. Accordingly. Bauman / International Review of Financial Analysis 16 (2007) 496–507 Table 1 Descriptive statistics (N = 173) Variable RATING TAE TAP LEVE LEVP LEVME LEVMP ROAE ROAP SRAE SRAP PME PMP VRE VRP VRME VRMP GUAR Mean 9.08 0. The suppression of total assets also results in significantly higher ROA under the equity method.07 4. LEV is total liabilities divided by the book value of common equity.045 0. Table 2 presents a correlation matrix including all model variables.650 3.01 b0.01 RATING is the S&P long-term issuer credit rating (a rating of “AAA” is assigned a value of 1 and a rating of “D” is assigned a value of 22).040 0. thereby netting its share of the investee's assets against its share of liabilities.869 0.01 b0.269 0.272 0. the investor's share of each of the investee's financial statement elements is combined on a line-byline basis with that of the investor.03 0. ROA is return on assets (calculated as net income divided by ending total assets).07 0.68 1.79 0.54 5.46 Wilcoxon b0. LEVM is total liabilities divided by the market value of common equity.528 0.D.307 1. VR is revenue volatility (calculated as the standard deviation of total revenues scaled by book value of common equity). PM is profit margin (calculated as net income divided by total revenues). 4.500 M. Finally.878 0.04 0.853 4.030 0. the standard deviation for LEVM (VRM) is much smaller than that for LEV (VR). except for the Pearson correlations with LEV and volatility of Consistent with Kothavala (2003). a firm reports its investment in a significant influence investee as a single line item in the balance sheet.043 0. Accordingly.889 2. under proportionate consolidation. Under the equity method.033 0.417 1. the investor's income statement contains its proportionate share of the investee's net income (loss) as a single line item.53 9.271 8.038 0. the extreme one percentiles of independent variable observations are winsorized to mitigate their influence.01 b0.614 0.051 0.036 0.01 b0.23 0.P.405 0.29 1. The correlations between bond rating (RATING) and each of the independent variables have the expected signs and are significantly different from zero.

04 VRMP 0.65 − 0.05 SRAE 0.13 0.03 0.30 0.31 − 0.77 − 0.00 − 0.39 −0.11 0.33 − 0.31 0.51 −0.09 0.58 0.25 − 0.13 0.01 0.23 − 0.41 − 0.37 − 0.40 − 0.31 0.95 − 0.58 – 0.94 − 0.29 − 0.15 TAE −0.56 − 0.13 − 0.32 0.64 0.14 − 0.15 VRP 0.36 0.37 − 0.21 – Correlation coefficients significantly different from zero at p-values less than 0.16 −0.16 −0.36 0.53 0.28 − 0.63 0.10 0.26 0.19 – 0.01 0.31 − 0.62 0.32 − 0.64 0.05 are in boldface type.34 0.44 0.13 0.01 −0.98 0.66 − 0.25 − 0.30 − 0.30 − 0.67 −0.61 0.97 − 0.58 0.11 −0.61 0.57 0.50 −0.02 0.04 0.95 0.96 0.35 0.23 − 0.61 − 0.03 ROAP −0.50 − 0.27 − 0.09 LEVP 0.15 VRME 0.18 −0.06 − 0.10 TAP −0.02 −0.34 −0.33 − 0.60 0.13 0.24 − 0.98 – 0.08 −0.98 – − 0.42 − 0.02 PMP −0.37 − 0.60 0.28 −0.33 – 0.02 − 0.58 0.31 0.28 −0.11 0.34 0.21 − 0.97 – − 0.60 0.50 0.41 − 0.11 0.13 GUAR 0.12 0.16 ROAE −0.13 − 0.98 −0.37 0.18 − 0.10 − 0.06 0.31 − 0.26 0.55 − 0.99 0.28 − 0.33 −0.58 0.58 0.35 0.30 0.62 0.95 − 0.07 − 0.51 − 0.31 0.05 0.65 0.09 LEVME 0.36 0.12 0. Bauman / International Review of Financial Analysis 16 (2007) 496–507 Table 2 Correlations between bond ratings and equity method and proportionate consolidation amounts.76 0.44 − 0.11 0.08 − 0.35 −0.11 −0.62 − 0.59 − 0.20 − 0.10 LEVE 0.53 − 0.00 −0.57 0.01 − 0.30 − 0.60 0.31 − 0.56 0.15 −0.14 − 0.78 − 0.19 0.17 − 0.19 − 0.01 0.14 0.30 0.99 – − 0.32 −0.31 − 0.11 0.48 − 0.11 − 0.63 0.25 −0.16 − 0.36 0.10 − 0.99 – − 0.20 0.10 0.14 − 0.02 0.44 −0.99 0.02 VRE 0.04 − 0.39 0.55 – 0.67 0.84 0.04 − 0.51 − 0.45 0.65 0.37 − 0.62 – 0.20 − 0.P.34 − 0.31 −0.60 − 0.04 PME −0.20 0.08 − 0.09 − 0.32 – 0.35 0.32 0.06 0.03 − 0.07 0.95 0.93 – 0.25 −0.07 − 0.62 0.50 0.05 0.06 − 0.97 – 0.97 − 0.47 −0.27 0.40 −0.32 −0.09 0.08 −0.15 0.25 0.36 0.34 0.14 − 0.28 0.06 0.06 0. Spearman (Pearson) correlations in upper (lower) triangle (N = 173) Rating Rating TAE TAP LEVE LEVP LEVME LEVMP ROAE ROAP SRAE SRAP PME PMP VRE VRP VRME VRMP GUAR – −0.37 0.01 0.03 − 0.03 −0.33 −0.24 − 0.42 − 0.14 LEVMP 0.19 −0.34 − 0.27 −0.25 −0.05 SRAP 0.14 – 0.84 0.73 −0.37 − 0.14 0.41 − 0.36 − 0.01 − 0.51 − 0.33 0.28 − 0. All variables are as defined in Table 1.99 – −0.06 − 0.07 0.01 − 0.99 −0.16 0.02 0.29 0.95 0.50 − 0.83 0.08 − 0.54 − 0.M.63 0.19 − 0. 501 .33 −0.48 0.20 0.59 − 0.95 − 0.96 − 0.30 0.06 − 0.10 – 0.58 −0.03 −0.74 − 0.15 − 0.13 0.49 0.31 −0.47 −0.17 − 0.26 − 0.83 0.09 0.55 0.75 0.14 − 0.25 −0.16 − 0.01 0.05 − 0.31 − 0.21 − 0.56 0.64 0.

05 (⁎⁎)..684 TA(E. while the equity method model has an adjusted R-squared of 0. the condition indices for the regression models are less than 8. White.672.02) 0.37 (− 0.24⁎⁎⁎ (2. 1967. The robust estimator relaxes the assumption of independence of the observations.44) – −50.36) – 0. One-sided hypothesis tests are performed for those coefficients expected to have directional relations.661 (P) − 1.13⁎⁎⁎ (3. which ranges between 0.001 0. The correlations between the independent variables are generally moderate.95) −0. collinearity is not a serious concern. based on Huber–White robust standard errors. 1993). Results from regression analysis The results from estimating models (1) and (2) via OLS regression are presented in the third and fourth columns of Table 3.64) −4.76⁎⁎⁎ (− 8. Despite this high degree of correlation.14⁎⁎⁎ (4. A notable exception is the correlation between ROA and PM. For the Pearson correlations. Kuh.18⁎ (1.43⁎⁎⁎ (2.90⁎⁎⁎ (− 7. well below the rule-of-thumb critical value of 30 (Belsley.43⁎⁎ (2. Bauman / International Review of Financial Analysis 16 (2007) 496–507 revenue (VR). All variables are as defined in Table 1. respectively.43) – − 17.06) E b P 0. the correlations are much greater for LEVM and VRM (ranging from 0. & Welsch. The results indicate that proportionately consolidated financial statements have greater relevance for explaining bond ratings.89) 15. As the numerators for these measures (i. clustering observations by firm produces correct standard errors even if the observations are correlated and heteroscedastic (Rogers.P) VR(E.19) 26.10⁎⁎⁎ (3.70) – 1.93) 0. this reflects the high correlation between sales and total assets for manufacturing firms. One-sided hypothesis tests are performed for those coefficients expected to have directional relations.33) 0. While the Spearman correlations between RATING and both LEV and VR are significantly positive (ranging from 0. 3.P) PM(E.28⁎ (1. The BBS p-value is from the test of relative information content in Biddle et al.P) LEV(E. Substituting the market value of equity for book value in the leverage and revenue volatility variables strengthens their relation with RATING.26⁎⁎ (2.001.67⁎⁎⁎ (2. However.56) 20. as the BBS test of relative information content rejects equality for explaining RATING with a p-value of 0.96. N = 173) Variable Predicted sign − + + − + ? + + + Models (1) and (2) (E) − 1.01 (⁎⁎⁎). This result is contrary to Kothavala (2003).60) – 0.P) VRM(E.71⁎⁎ (2.631. The proportionate consolidation model has an adjusted R-squared of 0.08) − 0.28).e.16) 23.672 Models (1′) and (2′) (E) −1.64 (− 0.2. these correlations are strongly positive for LEVM and VRM (ranging between 0.65) −1.631 (P) −1.P) SRA(E.91 (1.29⁎⁎ (− 2.35⁎ (− 1. there is no significant relation between RATING and either LEV or VR. are in boldface type.23⁎⁎⁎ (− 4.36⁎⁎⁎ (− 4. 1980).38) – – E b P 0.P) GUAR BBS p-value Adj R2 Coefficient estimates significantly different from zero at p-values less than 0.18) − 30.29) 30.30) 1.94 and 0. statistical significance is assessed using Huber–White robust standard errors (Huber. (1995).11) – 0.41⁎⁎⁎ (−5. As the model is estimated on a pooled basis.71⁎⁎⁎ (−5.52) 0.11) 20.66) – – 0.54 and 0.10 (⁎). . net income) are the same. Further.32) − 0. 1980).97⁎⁎ (2. who finds that amounts based on equity Table 3 Summary statistics from OLS regression of bond ratings on equity method and proportionate consolidation accounting amounts and ratios (robust t-statistics in parentheses.66 to 0. or 0.47⁎⁎⁎ (− 6. 0.502 M.P) LEVM(E.P.64).74). Specifically.045 0.61 (− 0.P) ROA(E.23 to 0.75⁎⁎⁎ (2.

however.33) and proportionate consolidation (− 50. The results from estimating models (1′) and (2′) are presented in the last two columns of Table 3.35 ⁎ 0.S.18. Nanda. Other than the BBS test results. and/or (c) sample composition. Bauman / International Review of Financial Analysis 16 (2007) 496–507 503 method accounting (adjusted R-squared = 0.71 ⁎ 0. This difference is attributed to the explicit recognition of investee liabilities under proportionate consolidation. sample composition is the most likely cause of the differing BBS test results. significant-influence equity investments encompass associates. With respect to accounting methods. This change in results is attributed to the substitution of market value of equity for book value of equity. 1993). the estimates for all variables have the predicted sign.06) has the expected positive sign. and Canada. First. For the proportionate consolidation (equity method) model. In addition.661) versus proportionate consolidation (0. the current sample consists exclusively of manufacturing firms. the marginal effect of PM on RATING has the expected negative sign under both the equity method (− 17. Of the estimates with the expected sign.33) is positive and marginally significant at the 0. GAAP. With respect to the bond rating process. and Wysocki (2003) document low earnings management ‘scores’ in both the U.P.935 + 20.7 With respect to individual coefficients.S. In the present study.684) regressions. Webster and Thornton (2004) find no evidence of significant differences in accrual quality over the period 1990–2002 between Canadian firms reporting under Canadian GAAP and U. several additional analyses are conducted (results not tabulated). Leuz. and Canadian GAAP.24. While the estimate for proportionate consolidation (0. etc. her sample appears to be more heterogeneous as the primary sample selection criterion is the existence of detailed data for joint venture investments. whereas Kothavala (2003) focuses exclusively on joint ventures. it is not significant. ROA.93).095 level. The unexpected negative coefficient estimates for the VR terms are consistent with Kothavala (2003). Based on the above. While the inclusion of GUAR reduces the difference between adjusted R-squared for the equity method (0.S. except for VR. as in Kothavala (2003). yearly indicators are added to the model to control for Another sample-related possibility is that a fundamental difference exists in the nature of investments investigated. This increase in explanatory power could be due to differences in (a) U. The coefficient estimates for VRM are statistically significant with the expected positive sign under both the equity method (0. If these investments are characteristically different. To assess the robustness of the results from models (1′) and (2′).98). (b) bond rating methodologies. the model modifications do not affect the inference that proportionately consolidated financial statements have greater relevance for explaining bond ratings. t = 1. it may explain some of the differences in results. t = 2. the BBS test of relative information content indicates that the difference continues to be significant (at the 0. With respect to guarantees.32) have significantly greater explanatory power than amounts based on proportionate consolidation (0. Further.30) and proportionate consolidation (1. partnerships.91.97. LEV.43 = − 26.M.S. 7 . Based on the sample mean values of asset turnover (ATO). t = 1. the coefficients on TA.22). With respect to sample composition. the coefficient estimate on GUAR for the equity method regression (1.61 = − 16. and Canadian accounting standards (Doupnik & Salter. the adjusted R-squared is 205% (97%) higher in the current study.045 level).906 − 0. and SRA all are significantly different from zero. a review of the methodologies and criteria as described on the Standard and Poor's and Dominion Bond Rating Service web sites reveals no substantive differences. Thus. firms reporting under U. joint ventures. t = 2. her estimates for the VR terms are not significantly different from zero.S. differences in GAAP are not a likely cause given the overall similarity between U. the most notable difference across the studies is the relative explanatory power of the models. While Kothavala (2003) does not provide data regarding industry membership.

N = 173) Variable Predicted sign − + − + ? + + Coefficient (z-statistic) (E) −1.30) 22. are in boldface type.75) 16.P) LEVM(E.61⁎⁎⁎ (2.P) SRA(E. To assess the robustness of the ordered logit results.10 (⁎).35. net income is adjusted for non-recurring items by removing special items (Compustat item #17).92) 0.01 (⁎⁎⁎).85) − 355. Finally. the likelihood ratio test utilized in Hillegeist. proportionately consolidated financial statements continue to have significantly greater relevance for explaining bond ratings. the battery of sensitivity tests described above is performed (results not tabulated).31⁎⁎ (1. Cram. Bauman / International Review of Financial Analysis 16 (2007) 496–507 Table 4 Summary statistics from ordered logit regression of bond ratings on equity method and proportionate consolidation accounting amounts and ratios in models (1′) and (2′) (robust t-statistics in parentheses.10⁎⁎⁎ (−3. These results are consistent with the OLS results in Table 3.04⁎⁎⁎ (3.51) 0. Fourth.001 −345. and Lundstedt (2004) rejects equality of information content in favor of proportionately consolidated financial statements at the 0.02⁎⁎⁎ (2.99 (− 0. respectively) exceed that for the equity method model (− 355.. based on Huber–White robust standard errors.42 (0.54) E b P 0.58 (0. The LR test p-value is from the logit-based Vuong likelihood ratio test from Hillegeist et al. (2004).45) 0.21) 20.21) 0. Both the log likelihood and pseudo R-squared for the proportionate consolidation model (− 345. 4.215). adjusted for income taxes by multiplying by 1 minus the statutory tax rate of 0.05) 1. 0. R2 Coefficient estimates significantly different from zero at p-values less than 0. time effects. proportionately consolidated financial statements have significantly greater relevance for explaining bond ratings.54) − 7. Specifically. Most important.9 0.21⁎⁎⁎ (−3. In each of these alternative specifications.P) GUAR LR test p-value Log likelihood Psuedo adj. Second. an alternative to winsorization as a means to handle influential observations is utilized. based on the BBS test of relative information content.504 M. Summary and concluding remarks This study provides additional evidence regarding the association between bond ratings and financial statement amounts under proportionate consolidation versus the equity method.P. In each of these estimations. Utilizing a sample of Canadian firms. All variables are as defined in Table 1.67⁎⁎ (2. t = 0.P) PM(E.237 TA(E. the 2 firms (7 observations) with negative book value are included in the estimation.9 0.9 and 0.9. or 0.93) −40. The results from estimating models (1′) and (2′) via ordered logit are presented in Table 4.P) VRM(E.69⁎⁎ (1.85) is no longer significantly greater than zero.001 level. with one exception — the coefficient estimate for GUAR in the equity method regression (0.62 (0.91⁎⁎⁎ (2. Third. both LEV and VR are log transformed due to skewness.62. One-sided hypothesis tests are performed for those coefficients expected to have directional relations.215 (P) −1.50) 1.P) ROA(E.15⁎⁎⁎ (−3. Keating. Kothavala (2003) surprisingly finds that equity method . 0. 1980).05 (⁎⁎).57) 0. those observations with studentized residuals having absolute values in excess of 3 are deleted from the sample (Belsley et al.237.

At December 31. See Bauman (2003) for a more complete discussion of issues associated with proportionate consolidation based on footnote data. When sales of inventory are made between investor and investee. In contrast to Kothavala (2003).1 120. .1) = $60. pro forma proportionate consolidation involves removal of the investment account ($60.1 1022. realization does not occur until the inventory is consumed in operations or resold to an unrelated party.2 1004. Since the information necessary to make this adjustment is not disclosed.4 296. manufacturing firms.5)($365. Bauman / International Review of Financial Analysis 16 (2007) 496–507 505 statements are more relevant for bond ratings than are proportionately consolidated statements. Although not applicable to this example. no adjustment is made. goodwill is recorded in cases where the balance in the investment account exceeds the proportionate share of the investee's net assets. a significant influence investee. on a pro forma basis. Appendix A The following example illustrates how footnote disclosures for a sample firm are used to proportionately consolidate.5 − 245.9 0. the results indicate that proportionately consolidated financial statements have greater relevance than equity method statements for explaining bond ratings.5 $ 365. Financial data follow: Coke Bottling ($ millions) Balance sheet (equity method) Investment in Piedmont Other assets Total liabilities Shareholders' equity Income statement (equity method) Revenues Expenses Net income Summarized financial statement information for Piedmont disclosed in footnotes of Coke Bottling Total assets Total liabilities Partners' equity Revenues Net income $ 60.2) and substitution of the investor's share of investee assets and liabilities [(0. This result is not altered when guarantees of investee obligations are included in the model.P. Consolidated (“Coke Bottling”) reports one material equity method investment — a 50% interest in Piedmont CocaCola Bottling Partnership (“Piedmont”). With respect to the income statement. These findings add to the ongoing debate regarding the usefulness of financial statements prepared under alternative methods of accounting for significant influence equity investments.4 17.2 9. net income reported under proportionate consolidation is equal to that reported under the equity method.3 1047. The present study examines the same issue. the amount of revenues reported under pro forma proportionate consolidation should be adjusted for unrealized intercompany sales. Accordingly.2].7 1013. 2001.5 245.8 With respect to the balance sheet.S. using a sample of U. This result is attributed to greater sample homogeneity. Coca Cola Bottling Co.M.

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