Asymmetric Valuation Adjustments in Accumulated Other Comprehensive Income

Abstract

The book value of equity is important in debt contracting, firm equity valuation, and managerial bonus determination, and thus subject to discretionary adjustments by management. Even though annual Other Comprehensive Income (OCI) amounts are independent of the current period profit and loss, annual OCI does constitute a significant proportion of equity book value and thus may also be the object of discretionary management. In this study, we use changes in firms' market value of equity to measure variations in business conditions, and examine whether firms adjust their OCI amounts to manage the book value of equity. We find that the book value of equity increases (decreases) by approximately 0.09% (0.003%) through changes in OCI amounts, for a 1% improvement (deterioration) in the market value of equity over the prior year. These findings of asymmetric adjustments persist when we use a three-year window period that contains more information and accounting reverses. Further analyses indicate that asymmetric adjustments are more significant for firms with more serious agency problems (measured by corporate social responsibility and CEO duality). The findings are robust when changes in net sales are used as the proxy for variations in business conditions and under various specifications.