An Empirical Analysis of Differential Capital Market Reactions to Extraordinary Accounting Items

Corporations are required to disclose separately and distinctively measurements of transactions or economic events defined by the accounting profession to be extraordinary in nature relative to the typical operations of the firm. An assumption is apparently being made that separation of extraordinary and nonextraordinary income numbers provides additional information for assessment of expected security returns and/or security risk based on the implications of the underlying economic phenomena. This study provides empirical evidence on the marginal information content of extraordinary accounting numbers. A data file of reported extraordinary items for 332 firms over the years 1967-1972 was generated and capital market price reactions to different types of extraordinary items were examined relative to the nonextraordinary earnings numbers. A sample of firms which did not report extraordinary items will be used for comparative purposes. It is indicated here that substantially different time series patterns of unexpected security rates of return are obtained based on signs of reported extraordinary accounting items and signs of forecast errors for nonextraordinary earnings. Also differential information content for alternative-categories of extraordinary items is reported. The results reported here may be viewed as an extension of earlier studies which examined both the time-series behavior and the information content of accounting earnings numbers.