Accounting for Joint Ventures and Associates in Canada, UK, and US: Do US Rules Hide Information?

Journal of Business Finance & Accounting, 33(3) & (4), 395 417, April/May 2006, 0306-686X doi: 10.1111/j.1468-5957.2006.00609.x Accounting for Joint Ventures and Associates in Canada, UK, and US: Do US Rules Hide Information? KAZBI SOONAWALLA* Abstract: Unlike US GAAP, accounting principles in Canada and the UK require disclosure of disaggregated components of joint ventures and associates. Using comparative analysis of Canadian, UK and US data, this study investigates the potential loss of forecasting and valuation relevant information from aggregating joint venture and associate accounting amounts. Findings show that aggregating joint venture and associate investment numbers, and aggregating joint venture revenues and expenses, each leads to loss of forecasting and valuation relevant information. Thus, current US accounting principles likely mask information that financial statement users could use to predict future earnings and explain share prices. Keywords: forecasting joint ventures, associates, international accounting, value relevance, earnings 1. INTRODUCTION This study investigates whether financial statement information relating to joint ventures and associates is relevant for earnings forecasting and equity valuation. 1 The study bases inferences on the association between recognized amounts for various income statement and balance sheet components, and current share prices and future earnings, to address the following questions: (1) Is there loss of *The author is from the London School of Economics and Political Science. This paper is based on the author s doctoral dissertation at Stanford University. She is indebted to her thesis chair, Mary Barth, for invaluable support and guidance. She sincerely thanks her other committee members Bill Beaver and George Foster for helpful suggestions. She is very grateful to Peter Pope, an anonymous referee, and seminar participants at the 2005 JBFA Conference, Columbia University, Emory University, London Business School, London School of Economics and Political Science, Oxford University, Stanford University, University of California at Berkeley, and University of Washington for helpful comments. She gratefully acknowledges financial assistance from the Arthur Andersen Foundation and the John M. Olin Foundation. Address for correspondence: Kazbi Soonawalla, Department of Accounting and Finance, London School of Economics, Houghton Street, London WCZA ZAE, UK. e-mail: k.soonawalla@lse.ac.uk 1 Associates is the term used to describe equity investments in associated companies or other equity investments. They are known as long-term investments in Canada. Throughout this paper the term associates is used for these investments, and associate earnings refers to earnings from other equity investments or associated companies. Journal compilation # 2006 Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA. 395

396 SOONAWALLA information for earnings forecasting and equity valuation when joint venture earnings are aggregated with earnings from associates, and joint venture investment values are aggregated with associate investment values? (2) Is there loss of information for forecasting and valuation purposes when joint venture revenues and expenses are aggregated together as joint venture earnings? An issue currently debated internationally is the appropriate method of accounting for joint ventures and associates. In most countries either the equity method or proportional consolidation is required for joint venture investments, and the equity method is required for associates. 2 Some countries, such as Canada and the United Kingdom (UK), require joint venture and associate amounts to be reported separately, as well as additional disclosures relating to these investments. Other countries, such as the United States (US), require no additional disclosures and do not even require that joint venture and associate amounts be reported separately. Due to the considerable diversity in practice, the accounting treatment for these investments is of interest to standard setters. In September 2002, the International Accounting Standards Board (IASB) and national standard setters concluded that accounting for interests in joint ventures should be the subject of an international convergence project. In March 2003, the Canadian Accounting Standards Board asked financial statement preparers whether they would favour a change in reporting practice from proportional consolidation to the equity method, and in April 2003, the Australian Accounting Standards Board began a re-examination of IAS 31, the relevant international accounting standard for interests in joint ventures. In July 2004, it was recommended that the IASB s and US Financial Accounting Standards Board s (FASB) joint Convergence team begin a short-term project with the objective of achieving convergence, and that the IASB s Joint Ventures research team begin a long-term project with a view to a more fundamental review of joint venture arrangements. Accounting treatments for joint ventures and associates vary considerably, as demonstrated by the differences in US, Canadian, and UK GAAP. The equity method is required in the US, whereby the sum of net earnings from joint ventures and associates (also called equity earnings), and the sum of net investments in joint ventures and associates (also called equity investments), are presented as single line items in the income statement and balance sheet, respectively (APB 18, 1971). Operating results are aggregated in two ways. First, joint venture earnings are aggregated with earnings from other equity investments in associated companies. Second, joint venture revenues and expenses are aggregated together as joint venture earnings. Although the aggregate of joint venture and associate amounts are recognized under US GAAP, disaggregated earnings and equity book value components of these investments are not reported separately. US firms do not disclose information sufficient to conduct empirical analyses on joint venture and associate accounting amounts. Canadian and UK GAAP require that firms disclose their pro rata shares of joint venture revenues, operating income, assets, and liabilities. 3 Canadian GAAP 2 This study is not concerned with the differences between the equity method and proportional consolidation. Instead, it focuses on the disclosure of disaggregated accounting amounts relating to joint ventures and associates. 3 In this paper the terms firm and investor firm refer to the firm that has entered into the joint venture arrangement and/or owns an interest in the associate. These firms are often referred to as co-venturers, joint venturers, or parents in the academic literature and popular press.

ACCOUNTING FOR JOINT VENTURES 397 requires proportional consolidation for reporting joint venture interests along with disclosures of disaggregated revenues, earnings, assets, liabilities, and cash flows. Under proportional consolidation, the firm s pro rata share of each of the assets, liabilities, revenues, and expenses that are subject to joint control is combined on a line-by-line basis with the firm s other assets, liabilities, revenues, and expenses. UK GAAP requires the gross equity method for joint ventures, whereby disaggregated shares of joint venture revenues, earnings, assets, and liabilities are disclosed in addition to equity method recognition. Although the accounting treatments and disclosure requirements for joint ventures are different under Canadian and UK GAAP, firms in both countries are required to provide disaggregated information sufficient to address the research questions in this study. Both countries use equity method reporting for associates, and associate earnings and investment amounts are reported separately from joint venture earnings and investments. 4 The availability of this data creates a rich environment for investigating the information lost when this disaggregate information is not available. This study investigates the potential loss of information from failing to provide detailed disaggregated income statement and balance sheet information, using samples of Canadian, UK, and US firms. Aggregated accounting amounts that diminish the information used to predict future earnings and value the firm reduce forecasting and value relevance of financial statements, respectively (Barth et al., 2001). The evidence provided bears directly on reporting practices under Canadian and UK GAAP. The evidence also bears indirectly on current issues facing the US FASB regarding consolidations and off-balance sheet entities. The study predicts that presenting aggregated data for joint ventures and associates results in loss of information that could otherwise be used to forecast future earnings and explain share prices. It tests these predictions by estimating relations between future earnings or current share prices, and net income, joint venture earnings components, associate earnings, and their corresponding equity book value components. The investigation is performed on a sample of 105 Canadian firms and 132 UK firms that have some form of joint venture investments and possibly associate investments in the late nineteen nineties. 5 Where possible, analogous analyses are conducted on a sample of US firms. While there may be aspects of non-comparability across the samples, this analysis establishes the broad relation between firm net earnings and equity earnings for a wider range countries and firms. It permits inferences about the potential benefits of additional disclosures in the US, from Canadian and UK data. In addition to the main analyses described in the research design, the study conducts sensitivity analyses using different specifications such as restricting the analysis to positive and negative earnings samples, using net abnormal earnings instead of net earnings, and using alternative deflators. It also describes and compares the Canadian and UK joint venture samples with larger samples of the two countries. The results are mixed and suggest further enquiry. Initial findings show that equity earnings are incrementally valuation relevant over firm net income, across the Canadian, UK, and US samples. This establishes that the valuation relation for 4 Disaggregated amounts on associate revenues and expenses are not disclosed in either country. 5 The relevant accounting standards requiring joint venture and associate amounts to be separately disclosed have been in effect since 1996 in Canada and 1998 in the UK.

398 SOONAWALLA equity earnings is comparable in the three accounting jurisdictions. Inconsistent with predictions, aggregating joint venture and associate earnings does not appear to suppress earnings forecasting and valuation relevant information, but aggregating joint venture and associate investment book value numbers, does suppress forecasting and valuation relevant information. As predicted, aggregating joint venture revenues and expenses results in loss of forecasting and valuation relevant information. Overall, the results indicate that failure to report disaggregated information on joint ventures and associates masks information that is potentially useful to financial statement users. The rest of this paper proceeds as follows. Section 2 describes relevant accounting standards under Canadian, UK, and US GAAP. Section 3 reviews related background literature. Section 4 presents the research design. Section 5 presents descriptive statistics and findings. Section 6 presents the sensitivity analyses and Section 7 concludes. 2. RELEVANT ACCOUNTING METHODS FOR JOINT VENTURES AND ASSOCIATES Currently, no single definition or accounting method for joint venture investments exists across accounting jurisdictions or within the United States (AICPA, 1979; Nobes and Parker, 2002; Roberts et al., 1998; and Milburn and Chant, 1999). The key feature that sets joint ventures apart from other investments and operations is that joint ventures are jointly controlled by investor firms. Joint control is the sharing of power between co-venturer firms: no one firm unilaterally controls joint ventures, and the joint consent of all co-venturers is required for major operating and financing policy decisions. In contrast to joint control, firms have participating interests in associates and exercise significant influence over the associates activities. The joint consent of all firms is not required for operating and financing decisions of associates and, in general, firms have less control over associates than over joint ventures. While significant influence gives the power to participate in financial and operating policy decisions of the investee (IAS 28, 1988), it gives the firm less power and decision-making ability over associates financial and operating activities than joint control or full control (FRS 9, paragraph 6, 1997). One of the contentious issues surrounding accounting treatments for joint ventures is that not all accounting jurisdictions agree on the definition of joint control, which is the key defining feature of joint ventures. 6 The G4 þ 1 proposed a definition that is different from the definition used in the relevant international accounting standard (IAS 31, 1990). The Canadian and UK definitions of joint ventures also vary. Under Canadian GAAP, jointly controlled assets, operations, and enterprises are considered joint ventures. These jointly controlled assets and operations need not be entities distinct from the firm. Under UK GAAP, joint 6 Under Canadian GAAP, a joint venture is an economic activity resulting from a contractual arrangement whereby two or more venturers jointly control the economic activity (CICA 3055.03). Under UK GAAP, a joint venture is an entity in which the reporting entity holds an interest on a long-term basis and is jointly controlled by the reporting entity and one or more other venturers under a contractual arrangement (FRS 9, paragraph 4). US GAAP only talks about incorporated joint ventures and these would be corporations owned and operated by a small group of businesses (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group (APB Opinion No. 18).

ACCOUNTING FOR JOINT VENTURES 399 ventures must be distinct entities, and thus jointly controlled assets and operations are not considered joint ventures. 7 Since 1996, Canadian GAAP has required proportional consolidation of joint ventures with additional disclosures (CICA, 1996). Proportional consolidation accounts for the firm s interest by consolidating in its financial statements the firm s share of joint venture assets, liabilities, revenues, and expenses. In Canada, the firm is also required to disclose the following amounts related to its interests in joint ventures: (a) current and long-term assets, (b) current and long-term liabilities, (c) revenues, expenses, and income, and (d) cash flows from operating, financing, and investing activities. 8 The treatment for associates is different from that for joint ventures. Canadian GAAP requires that associate investments be accounted for using the equity method, whereby net operating earnings from and net investments in associates are represented by single line items in the income statement and the assets section of the balance sheet, respectively (CICA, 1994). UK GAAP has required the gross equity method for joint venture investments since 1998 (FRS 9, 1997). This method requires equity method recognition in the income statement and balance sheet, with the firm s shares of the gross assets and liabilities underlying the investment shown, in aggregate, on the face of the balance sheet. The firm s share of joint venture earnings is presented as a separate line item in the income statement. Similarly, joint venture revenues are disclosed as an additional line item in the income statement before equity method revenues. Under UK GAAP, as with Canadian GAAP, associates are accounted for using the equity method. In the US, the equity method is required for joint ventures and associate investments whereby the sum of joint venture and associate earnings is presented in aggregate in the income statement and the aggregate net investment in joint ventures and associate investments is presented in the balance sheet (APB 18, 1971; AICPA, 1979; and Milburn and Chant, 1999). Ownership interests in both joint ventures and associates usually range from 20 to 50 percent, so ownership amounts alone do not help distinguish between joint ventures and associates. The distinguishing feature is the amount of control the firm has over the investment. Control over joint ventures and associates is shared, but by differing amounts, making them distinctive from each other and from other operations and activities that are fully controlled by the firm. The varying control levels for joint ventures and associates lends itself to investigate whether joint venture and associate accounting amounts should be disclosed separately, and whether joint venture revenues and expenses should be disclosed separately. The necessary disaggregate accounting amounts to investigate the research questions are available from Canadian and the UK firms. The study obtains data on joint venture revenues, earnings, and net investment amounts for Canadian firms from footnote disclosures, and calculates joint venture expenses as joint venture revenues minus earnings. The study also obtains associate earnings and investment amounts from the relevant line items in the income statement and balance sheet. For UK 7 Instead, jointly controlled assets and operations are accounted for using proportional consolidation. Disaggregate information on these investments is generally not disclosed making it difficult to include them in the analysis. The differences in definitions may hinder cross-country comparison to some extent. However, the key feature of joint control is required for Canadian and UK joint ventures. 8 Note that firms disclose the aggregate for these amounts across all their joint venture investments.

400 SOONAWALLA firms, the study obtains joint venture revenues, earnings, and net investment amounts, and associate earnings and net investment amounts from the income statement and balance sheet, respectively. Overall, the rules under Canadian and UK GAAP provide that the level of disclosure reflects the degree of the firm s control over the investee; i.e. disclosure is high for subsidiaries, intermediate for joint ventures, and low for associates (Flower and Ebbers, 2002). In contrast, US GAAP requires aggregation across investments that are inherently different in nature from each other and subject to different degrees of control. From forecasting and value relevance perspectives, permitting reporting of aggregated accounting amounts of joint venture and associate earnings, or joint venture revenues and expenses implies that the disaggregated components are not viewed to be relevant to financial statement users for predicting future earnings and estimating current share prices, respectively. If knowing the disaggregated accounting amounts is relevant to a financial statement user it can also be capable of making a difference to that user s forecasts and valuations. 3. REVIEW OF RELATED RESEARCH Prior research documents an association between joint venture investments and share prices (Koh and Venkatraman, 1991; Madhavan and Prescott, 1995; and Park and Kim, 1997). However, it does not document whether joint venture accounting amounts are associated with share prices. The extant literature also does not document whether there is a differential association between firm accounting numbers and joint venture and associate accounting numbers, and share prices. Three factors affect whether joint venture and associate earnings have different associations with prices. First, firms have different degrees of control over fully controlled operations, joint ventures, and associate investments. Firms control majority owned investments, jointly control joint ventures, and have only significant influence over associates. Some suggest that the power of joint control is substantively greater than significant influence and accordingly jointly controlled investments should be distinguished from other equity investments (Flower and Ebbers, 2002). Park and Kim (1997) find that the market reacts positively to joint venture announcements if the firm has more control over the joint venture, suggesting that degree of control affects equity valuation. Second, joint ventures tend to be of finite duration (Kogut, 1988; Park and Russo, 1996; and Williamson, 2000). Subramanyam and Wild (1996) show that earnings persistence is inversely related to probability of termination of the firm. 9 Conversely, high probability of joint venture termination might imply lower earnings persistence. If joint ventures also have lower earnings persistence, then Ohlson (1999) shows that this would be translated into lower association with market value of equity. 10 Third, joint ventures and associates may be in different lines of business or industry from the investor firm and accordingly, have earnings persistence 9 It is worth noting that persistence is not necessarily equivalent to duration. Lower duration of joint ventures implies lower market value of equity, but it is possible that earnings from these investments could be equally persistent to firm earnings while they exist. 10 Joint venture terminations often result in reallocation of ownership between the existing investor firms, where the firm effectively uses the joint venture as an option to expand (Kogut, 1991). This study does not explore reasons for joint venture termination.

ACCOUNTING FOR JOINT VENTURES 401 properties that better reflect the industry of the joint venture rather than that of the firm (Dieter and Wyatt, 1978; and Harrigan, 1988). Joint ventures may be formed to invest and expand in new markets that could result in unpredictable earnings and differing associations with market value of equity from other controlled and significant influence investments (Kogut, 1991). There is very little extant literature on accounting for joint venture investments. Graham et al. (2001) compare proportional consolidation and the equity method and find that proportionally consolidated financial statements are more useful in predicting future returns on shareholders equity than equity method financial statements. Kothavala (2003) investigates whether joint venture accounting numbers and ratios for a sample of Canadian firms are significantly associated with market risk proxies such as price volatility and bond ratings. She finds that disaggregated information on joint venture accounting numbers helps explain variation in market risk. However, Graham et al. (2001) and Kothavala (2003) focus only on Canadian firms with joint ventures. This study differs in that it focuses on the information lost from various levels of aggregation and uses data from Canadian, UK, and US firms, providing a comprehensive view of issues relating to accounting for joint ventures and associates. Maines et al. (2000) investigate the role of analyst knowledge and supplemental disclosures on joint venture investments. They examine whether analysts assign different equity values depending on whether a firm uses the equity method or proportional consolidation to report joint venture interests. They find that analysts with low familiarity in joint venture accounting rules assigned higher equity values to firms with equity method financial statements than to firms with proportionally consolidated financial statements. However, disclosure of separate joint venture financial information eliminated assigned equity value differences. Their study supports the idea that aggregating joint venture accounting amounts leads to loss of value relevant information. It also suggests that analyst perception of economically identical joint venture investments varies depending on the accounting treatment used and that these differences can be undone with additional disclosures. This study also contributes to the literature on the information content of earnings and its components. Prior research generally finds that disaggregating earnings into its components, such as cash flows, revenues, and segment earnings, increases the predictive ability and valuation relevance of earnings (Lipe, 1986; Wilson, 1986; Wilson, 1987; Bernard and Stober, 1989; Balakrishnan et al., 1990; Livnat and Zarowin, 1990; Swaminathan and Weintrop, 1991; Dechow, 1994; Barth et al., 1999; and Barth et al., 2005). This study extends prior research by partitioning joint venture and associate earnings and equity book value components, from firm earnings and equity book value to investigate loss of information from aggregation. 4. RESEARCH DESIGN (i) Disaggregating Joint Venture and Associate Earnings To investigate whether there is loss of information for earnings forecasting or equity valuation when joint venture earnings are aggregated with associate earnings, the study builds on the following set of equations:

402 SOONAWALLA NI tþ1 ¼! 0 þ! 1 NI t þ! 2 BV t þ " 1tþ1 P t ¼ 0 þ 1 NI t þ 2 BV t þ " 2t ð1þ ð2þ where P is share price at time t, NI is net income of the investor firm including joint venture and associate earnings, and BV is equity book value of the firm including joint venture and associate investments. NI and BV are included in equations (1) and (2) as summary measures of financial statement information (Ohlson, 1995; and Stark, 1997). The first research question investigates the potential loss of information from aggregating joint venture and associate earnings and investments, given net income and equity book value. Before testing this, the study establishes the general relation between net income and equity earnings, and firm equity book value and equity investment value. Given that the sum of joint venture and associate earnings are presented in the US as equity earnings, this investigation is carried out for Canadian, UK, and US firms. The estimating equations are: NI tþ1 ¼! 01 þ! 11 NI þ! 21 OI EQt þ! 31 BV t þ! 41 BV EQt þ " 3tþ1 P t ¼ 01 þ 11 NI t þ 21 OI EQt þ 31 BV t þ 41 BV EQt þ " 4t ð3þ ð4þ where NI is net earnings of the firm, OI EQ is equity earnings which is the sum of joint venture and associate earnings, BV is equity book value of the firm, and BV EQ is net equity investments which is the sum of net investments in joint ventures and associates. All variables, except price, are deflated by number of shares outstanding at fiscal year end. The study predicts that OI EQ and BV EQ are incrementally forecasting and valuation relevant, over bottom line NI and BV numbers, respectively. This would be supported if the coefficients on OI EQ and BV EQ are significantly different from zero. All equations are estimated with dividends per share, and with year and industry indicator variables (Pope and Wang, 2005). 11 After establishing the general relation above, the first research question tests whether the coefficients on joint venture operating earnings and associate earnings are statistically different, and for this OI EQ is disaggregated into OI JV and OI AS. Simultaneously, the study investigates whether the corresponding balance sheet components are statistically different for forecasting and valuation purposes. Disaggregating the equity book value coefficients is consistent with disaggregating the equity earnings variables, as presumably the joint venture and associate earnings are being generated by the joint venture and associate equity book value components, respectively. To this end, BV EQ is disaggregated into BV JV and BV AS. To address the first research questions, the study estimates equations (5) and (6) and tests whether! 22 ¼! 32,! 52 ¼! 62, 22 ¼ 32, and 52 ¼ 62.OI JV is 11 The income component in an Ohlson framework is generally net abnormal earnings, which are calculated using an assumed cost of capital and previous period book value. Instead of using abnormal earnings, the analysis uses net earnings and includes dividends as an independent variable. Pope and Wang (2005) show that including dividends in the equation is equivalent to including lagged book value together with current book value, when accounting is conservative. Econometrically, using either earnings or abnormal earnings should not make a difference.

ACCOUNTING FOR JOINT VENTURES 403 joint venture earnings, OI AS is associate earnings, BV JV is net investment in joint ventures, and BV AS is net investment in associates: NI tþ1 ¼! 02 þ! 12 NI t þ! 22 OI JVt þ! 32 OI ASt þ! 42 BV t þ! 52 BV JVt þ! 62 BV ASt þ " 5tþ1 ð5þ P t ¼ 02 þ 12 NI t þ 22 OI JVt þ 32 OI ASt þ 42 BV t þ 52 BV JVt þ 62 BV ASt þ " 6t ð6þ. The study predicts that the forecasting and equity valuation multiples on OI JV and OI AS are different, implying loss of information for financial statement users when joint venture and associate earnings are aggregated (Harrigan, 1988; Bierman, 1992; Subramanyam and Wild, 1996; and Park and Kim, 1997). As before, including bottom line NI and BV numbers permits the study to look at incremental information content of OI JV and OI AS, and BV JV and BV AS, relative to NI and BV, respectively. (ii) Disaggregating Joint Venture Earnings into Revenues and Expenses Building on the prior tests, the next set of tests investigates whether there is loss of information for earnings forecasting and equity valuation when joint venture revenues and expenses are aggregated into joint venture earnings. To do so, OI JV is disaggregated into REV JV and EXP JV, and the equalities! 33 ¼! 43 and 33 ¼ 43 are tested in equations (7) and (8). 12 Firm revenues are disaggregated from firm net income. Associate earnings, OI AS, are retained as a disaggregate earnings component, resulting in the following equations: NI tþ1 ¼! 03 þ! 13 NI t þ! 23 REV t þ! 33 REV JVt þ! 43 EXP JVt þ! 53 OI ASt þ! 63 BV t þ! 73 BV JVt þ! 83 BV ASt þ " 7tþ1 ð7þ P t ¼ 03 þ 13 NI t þ 23 REV t þ 33 REV JVt þ 43 EXP JVt þ 53 OI ASt þ 63 BV t þ 73 BV JVt þ 83 BV ASt þ " 8t ð8þ where REV is firm revenues not including joint venture revenues, REV JV is joint venture revenues, and EXP JV is joint venture expenses. Rejecting the magnitude equalities of REV JV and EXP JV coefficients would imply that presenting only the aggregate joint venture earnings number suppresses information that is useful to investors for earnings prediction and equity valuation purposes. The study also tests whether the coefficients on joint venture revenues are statistically different from the coefficients on firm revenues. 12 Readers are reminded that for associate investments the income statement has only a single line item showing associate earnings, and neither associate revenues nor expenses are disclosed.

404 SOONAWALLA Equations (3) through (8) are based on Ohlson (1999), which extends Olson (1995) by modelling earnings components. Although the components in Ohlson (1999) are modelled as transitory earnings, the model applies to any component of earnings (Barth et al., 1999). Ohlson (1999) requires these transitory components to be unpredictable, however Pope and Wang (2005) show that some irrelevant components may have predictive ability for other accounting items like abnormal earnings. (i) Data 5. DATA AND RESULTS The study uses data from Canadian and UK firms for the years 1995 2000 and 1997 2000, respectively. The data were identified using keywords like joint ventures, jointly controlled entities, joint arrangements, and FRS 9 for exhaustive country-specific searches on Global Researcher, Global Vantage, and Worldscope, to identify samples of Canadian and UK firms with interests in joint ventures. 13 The searches identified 105 Canadian firms and 132 UK firms that have joint venture investments and provide the relevant financial statement information for at least one year. 14 Some of these firms also have associate investments. Data on associates and joint ventures are hand collected from company financial statements. Specifically, joint venture earnings and revenues, joint venture net investments, associate earnings, and associate net investments are obtained from investor firm financial statements. Other financial statement information and price data are obtained from Compustat s Canadian Industrial Annual, Global Vantage s Global Commercial and Financial Services, and Datastream. Where possible, the study runs analogous investigations for a sample of US firms that report equity investments and earnings for the years 1995 2000. These firms are identified from Compustat s US Industrial Annual files where equity investment amounts are non-zero or non-missing. 1,903 such firms were identified. (ii) Descriptive Statistics Table 1 presents the industry sector membership of the Canadian, UK and US samples. In all three countries, manufacturing firms make up the largest industry group representing approximately 30% of the respective samples. For the UK and US samples, financial firms constitute the second largest group, at 16% and 18%, respectively. In Canada, however, mining firms constitute the second largest group 13 FRS 9 makes a distinction between joint ventures and joint arrangements. Joint ventures are accounted for using the gross equity method, whereas joint arrangements are accounted for using proportional consolidation. The search terms merely identify firms that potentially have joint ventures. Therefore, the search often identified firms that did not in fact have joint ventures as defined by FRS 9 and after careful examination of the annual reports these firms were excluded. 14 Recall that the relevant accounting standards have been in effect since 1996 for Canadian firms and 1998 for UK firms. Using restated observations results in a maximum of six years of data for Canadian firms and four years for UK firms.

ACCOUNTING FOR JOINT VENTURES 405 Table 1 Industry Sector Membership Canada UK US Industry SIC Codes No. of Firms % No. of Firms % No. of Firms % Agriculture 0000 0999 8 0.42 Mining 1000 1499 21 20.00 2 4.55 135 7.09 2900 2999 Construction 1500 1999 5 4.76 11 8.33 52 2.73 Manufacturing 2000 2899 37 35.24 39 29.55 615 32.32 3000 3999 Transportation 4000 4899 9 8.57 15 11.36 191 10.04 Utilities 4900 4999 8 7.62 12 9.09 121 6.36 Retail/Wholesale 5000 5999 8 7.62 14 10.61 124 6.52 Financial 6000 6999 8 7.62 21 15.91 341 17.92 Services 7000 8999 9 8.57 14 10.61 296 15.55 Public Admin 9000 9999 20 1.05 Total 105 100.00 132 100.00 1,903 100.00 at 20% of the total sample. The number of UK and US mining firms is negligible. Mining firms tend to carry out a large amount of their activities through joint ventures and joint arrangements, indicating that for these firms a material amount of their earnings and investments are in joint ventures. Furthermore, mining firms are often unusual in structure, and the differing industry distributions may affect inter-country comparability. Table 2, Panel A presents the descriptive statistics of the variables used in the study. 15 Mean (median) joint venture earnings, OI JV, constitute 25% (14%) of mean (median) net income, NI, for the Canadian firms and 20% (7%) of mean (median) NI for the UK firms. In comparison, associate earnings, OI AS, contribute a smaller portion of net income in both countries, so that total equity income comprises mainly of joint venture income. Whereas mean total equity income, OI EQ, is larger for US firms than for Canadian and UK firms, median US equity income is similar to that of Canadian firms and larger than that of UK firms. The mean net equity investment, BV EQ, is considerably larger for US firms than for Canadian and UK firms. However, the median value is smaller than that of Canadian firms and larger than that of UK firms. It is worth noting that the variables OI EQ and BV EQ are slightly different for the US sample than for the Canadian and UK samples. The Canadian and UK samples consist of those firms that have joint ventures and may also have associate investments. US firms do not generally distinguish between these two types of investments. Instead, as per US GAAP, all 20 50% investments are referred to as equity investments, regardless of the differing types of control arrangements firms might have over these investments. Given the specific and distinct accounting rules for joint ventures and associates in Canada and UK, it is possible that joint venture 15 To mitigate the undue influence of extreme observations the extreme 1 % of all observations are winsorised.

406 SOONAWALLA Table 2 Descriptive Statistics and Correlation s Panel A: Descriptive Statistics Canada (n ¼ 105) UK (n ¼ 132) US (n ¼ 1,903) Variable Mean Median Std. Dev. Mean Median Std. Dev. Mean Median Std. Dev. P 17.55 13.95 15.24 4.01 3.40 3.53 26.54 20.75 24.34 NI 1.13 0.87 1.99 0.21 0.15 0.29 10.62 1.20 68.68 REV 26.18 16.78 31.37 4.18 2.65 5.11 OI JV 0.28 0.12 0.43 0.04 0.01 0.06 OI AS 0.01 0.01 0.07 0.01 0.01 0.04 OI EQ 0.29 0.13 0.45 0.05 0.02 0.09 1.84 0.12 11.20 REV JV 3.69 1.29 6.59 0.27 0.08 0.54 EXP JV 3.42 1.11 6.34 0.25 0.06 0.51 BV 14.13 10.94 12.91 1.90 1.39 1.76 762.00 11.22 6,427.00 BV JV 2.61 1.24 4.33 0.15 0.05 0.26 BV AS 0.32 0.01 0.89 0.06 0.01 0.14 BV EQ 2.98 1.47 4.54 0.22 0.07 0.35 68.10 1.01 546.00 Panel B: Pearson Correlation s for the Canadian Sample (UK Sample) in Upper (Lower) Triangle P NI REV OI JV OI AS OI EQ REV JV EXP JV BV BV JV BV AS BV EQ P 0.60 0.35 0.21 0.19 0.23 0.14 0.13 0.70 0.24 0.12 0.26 NI 0.59 0.57 0.08 0.24 0.11 0.07 0.06 0.74 0.05 0.25 0.12 REV 0.25 0.32 0.14 0.21 0.17 0.30 0.30 0.62 0.04 0.18 0.08 OI JV 0.26 0.31 0.23 0.15 0.98 0.56 0.51 0.21 0.30 0.09 0.25 OI AS 0.16 0.14 0.30 0.21 0.31 0.16 0.15 0.28 0.01 0.10 0.02 OI EQ 0.28 0.32 0.30 0.89 0.60 0.56 0.50 0.24 0.28 0.07 0.23 REV JV 0.18 0.21 0.39 0.61 0.22 0.56 0.99 0.21 0.42 0.09 0.42 EXP JV 0.15 0.18 0.39 0.52 0.21 0.48 0.99 0.21 0.43 0.09 0.42 BV 0.52 0.56 0.27 0.36 0.29 0.41 0.25 0.22 0.26 0.23 0.30 BV JV 0.20 0.25 0.14 0.60 0.24 0.58 0.55 0.51 0.52 0.02 0.95 BV AS 0.22 0.17 0.31 0.20 0.82 0.51 0.23 0.22 0.29 0.25 0.29 BV EQ 0.25 0.28 0.24 0.56 0.53 0.68 0.54 0.51 0.55 0.91 0.61 Panel C: Pearson Correlation s for the US Sample P NI OI EQ BV BV EQ P 0.19 0.13 0.07 0.04 NI 0.86 0.89 0.84 OI EQ 0.91 0.91 BV 0.94 BV EQ Notes: P is price per share at fiscal year end. NI is net income of the firm. REV is revenues of the firm excluding joint venture and associate revenues. OI JV is joint venture earnings. OI AS is associate earnings. OI EQ is the sum of joint venture and associate earnings. BV is book value of equity at fiscal year end. BV JV is net investment in joint ventures. BV AS is net investment in associates. BV EQ is sum of net investments in joint ventures and associates. REV JV is joint venture revenues. n is number of firms in the samples. NI, REV, OI JV,OI AS,OI EQ, REV JV, EXP JV, BV, BV JV,BV AS, and BV EQ are deflated by number of shares outstanding at fiscal year end. Correlation coefficients significantly different from zero at p-values less than 5% are in boldface type.

ACCOUNTING FOR JOINT VENTURES 407 structures are a function of the accounting rules in place. This endogeneity is also a potential source of non-comparability across samples. Table 2, Panel B presents Pearson correlations for the Canadian and UK samples and Table 2, Panel C presents Pearson correlations for the US sample. 16 For both the Canadian and UK samples, joint venture and associate earnings have low correlation with each other and with net income and price, thereby suggesting that there will not be multicollinearity problems with these variables. Joint venture revenues and expenses are highly correlated with opposite signs for the Canadian and UK samples. For the US sample, OI EQ has a low correlation with price, P, but has a higher correlation with net income, NI, and net equity investment, BV EQ. Multicollinearity tends to increase the variance of the regression coefficients, thereby decreasing their significance. This will tend to bias against finding significant results and may result in less powerful hypothesis testing. (iii) Findings As a precursor to the equations addressing the primary research question, equations (3) and (4) are estimated where joint venture and associate earnings, and joint venture and associate investments, are aggregated into single line items called equity earnings, OI EQ, and equity investments, BV EQ, respectively. 17 In addition to Canadian and UK data, a sample of US data are also tested using this specification. The results in Table 3 show that, as predicted, valuation coefficients for OI EQ are generally significantly positive for all three countries. 18 The earnings forecasting coefficients are not different from zero for the Canadian and UK samples, but is significantly different from zero for the US sample. This indicates that equity earnings are not incrementally forecasting relevant for the Canadian and UK samples, but are incrementally equity valuation relevant. The t-statistics of the OI EQ coefficient are 1.17, 0.79 and 7.43 for earnings forecasting, and 2.95, 1.69 and 11.43 for equity valuation for the Canadian, UK, and US samples, respectively. 19 On the equity book value side, the forecasting and valuation coefficients on equity book value, BV, are generally significantly positive for all three samples. The exception to this is the forecasting coefficient on BV for the US sample. However, the negative sign on BV is consistent with prior findings for US studies (Barth et al., 1999; and Barth et al., 2005). The findings show that equity investments, BV EQ, are less incrementally forecasting relevant, but not incrementally valuation relevant for the Canadian sample. The findings also show that BV EQ is not incrementally forecasting relevant, but less incrementally valuation relevant than BV for the UK sample. Finally, the findings show that BV EQ is incrementally more forecasting and valuation relevant than BV for the US sample. Overall, the results in Table 3 16 Untabulated Spearman correlations are similar in magnitude and significance to Pearson correlations. 17 t-statistics are based on White (1980) heteroscedasticity-consistent standard errors. For all the regression analyses are conducted using year fixed effects estimation. 18 Throughout, including dividends per share does not alter the inferences. For expositional purposes, these are not tabulated. The coefficient on dividends per share is consistently significantly positive for earnings forecasting and equity valuation. For further understanding of this positive pricing of dividends see Hand and Landsman (2005). 19 The difference in sample size between the forecasting and valuation specification is due to the forecasting specification needing an additional year of data compared to the valuation specification.

408 SOONAWALLA Table 3 Summary Statistics from Regression of Future Earnings and Current Share Prices on Net Income, Total Equity Earnings, and their Corresponding Equity Book Value Components NI tþ1 ¼! 0 þ! 1 NI t þ! 2 OI EQt þ! 3 BV t þ! 4 BV EQt þ " 3tþ1 P t ¼ 0 þ 1 NI t þ 2 OI EQt þ 3 BV t þ 4 BV EQt þ " 4t Canada UK US NI tþ1 P NI tþ1 P NI tþ1 P Variable Predicted Sign NI þ 0.40 1.85 0.35 3.61 0.52 3.90 (5.80) (5.39) (2.96) (3.59) (14.37) (18.97) OI EQ þ 0.23 2.38 0.31 1.63 0.18 1.23 ( 1.17) (2.95) (0.79) (1.69) (7.43) (11.43) BV þ 0.07 0.68 0.03 0.38 0.01 0.49 (6.44) (6.04) (2.10) (2.51) ({5.13) (14.46) BV EQ þ 0.04 0.32 0.07 0.52 0.04 0.11 ({2.31) (1.03) ( 1.53) ({1.74) (8.23) (5.87) N 310 409 299 431 3,489 4,869 Adj R 2 0.54 0.52 0.40 0.48 0.81 0.30 Notes: P is price per share at fiscal year end. NI is net income of the firm. OI EQ is the sum of joint venture and associate earnings. BV is book value of equity at fiscal year end of the firm. BV EQ is sum of net investments in joint ventures and associates. NI, OI EQ, BV, and BV EQ are deflated by number of shares outstanding at fiscal year end. N is number of firm-year observations. t-statistics are based on White (1980) heteroscedasticity-consistent standard errors. suggest some comparability across the samples. Whereas valuation properties of OI EQ appear similar across the three countries, the valuation properties of BV EQ are different. 20 Next the study looks at the principle research question investigating the potential loss of information from aggregating joint venture and associate earnings. Summary statistics from estimating equations (5) and (6) are presented in Table 4. For these specifications, equity earnings, OI EQ, is disaggregated into OI JV and OI AS, and equity investment BV EQ is disaggregated into BV JV and BV AS. Given the unavailability of disaggregate US data, these tests are restricted to the Canadian and UK samples. To investigate the potential information loss, the equality of coefficients for 20 Differences in the samples may arise due to specification problems or absence of parameter restrictions as specified by Ohlson (1999). The Canadian and UK samples are much smaller than the US sample, making extensive parameter restrictions impractical. The larger US sample indicates that this sample is potentially capturing a much wider variety of firms than the Canadian and UK samples, which further reduces comparability. The large size of the US sample also makes it conducive to more powerful hypothesis testing.

ACCOUNTING FOR JOINT VENTURES 409 Table 4 Summary Statistics from Regression of Future Earnings and Current Share Prices on Net Income, Joint Venture Earnings, Associate Earnings, and their Corresponding Equity Book Value Components NI tþ1 ¼! 02 þ! 12 NI t þ! 22 OI JVt þ! 32 OI ASt þ! 42 BV t þ! 52 BV JVt þ! 62 BV ASt þ " 5tþ1 P t ¼ 02 þ 12 NI t þ 22 OI JVt þ 32 OI ASt þ 42 BV t þ 52 BV JVt þ 62 BV ASt þ " 6t Canada UK NI tþ1 P t NI tþ1 P t Variable Predicted Sign NI þ 0.35 1.71 0.36 3.71 (6.50) (4.08) (5.21) (5.14) OI JV þ 0.13 2.15 0.10 3.81 ( 1.06) (1.92) (0.77) (1.87) OI AS þ 0.07 0.02 0.31 2.01 (0.97) (0.15) (0.68) 0.93 BV þ 0.08 0.66 0.05 0.28 (7.35) (3.67) (5.21) (1.84) BV JV þ 0.08 0.36 0.04 1.24 ({1.82) (1.91) ({1.69) ({2.88) BV AS þ 0.13 0.36 0.24 2.21 (3.83) ( 1.61) (1.61) (2.13) N 310 409 299 431 Adj R 2 0.57 0.53 0.40 0.49 Tests p-value p-value p-value p-value Income s of OI JV and OI AS! 22 ¼! 32 22 ¼ 32! 22 ¼! 32 22 ¼ 32 0.34 0.20 0.25 0.09 Book value of equity s of BV JV and BV AS! 52 ¼! 62 52 ¼ 62! 52 ¼! 62 52 ¼ 62 0.00 0.00 0.07 0.05 Rejecting model in Table 3 in favour of disaggregated model in Table 4 0.00 0.02 0.25 0.00 Notes: P is price per share at fiscal year end. NI is net income of the firm. OI JV is joint venture earnings. OI AS is associate earnings. BV is book value of equity at fiscal year end. BV JV is net investment in joint ventures. BV AS is net investment in associates. NI, OI JV,OI AS, BV, BV JV, and BV AS, are deflated by number of shares outstanding at fiscal year end. N is number of firm-year observations. t-statistics are based on White (1980) heteroscedasticity-consistent standard errors. OI JV and OI AS,! 22 ¼! 32 and 22 ¼ 32, are tested. The individual t-statistics indicate that joint venture earnings are incrementally valuation relevant over net income for the Canadian and UK samples. However, associate earnings are not incrementally valuation relevant in either sample. Neither joint venture nor associate earnings are incrementally forecasting relevant. The null hypothesis of the equality of joint venture and associate earnings coefficients is not rejected for

410 SOONAWALLA forecasting and valuation. 21 The results suggest that associate earnings are a noisy measure and, overall irrelevant. Therefore, given net income, disaggregating them from joint venture earnings does not appear to provide more useful information. On the balance sheet side, the tests of equality of coefficients for BV JV and BV AS,! 52 ¼! 62 and 52 ¼ 62, are generally rejected for earnings forecasting and equity valuation for both the Canadian and UK samples, with p-values of 0.00 and 0.00, and 0.07 and 0.05, respectively. In comparing the models in Tables 3 and 4, changes in adjusted R-squared values are also relevant for determining the usefulness of finer information. The R-squared for the forecasting equation for the Canadian sample increases from 0.54 to 0.57, and from 0.52 to 0.53 for the equity valuation equation. For the UK sample, there is no increase in the R-squared of 0.40 for the forecasting equation, and a small increase from 0.48 to 0.49 for the equity valuation equation. Therefore, disclosing the disaggregated information is not associated with dramatic increases in R-squared. 22 Finally, in comparing the models in Tables 3 and 4, the study performs a J-test for choosing between two non-nested linear regressions (Davidson and Mackinnon, 1981). The results from this test reject the aggregate model in Table 3 in favour of the disaggregate model in Table 4 for all specifications, except the earnings forecasting model for the UK sample. Together, the results indicate that aggregating joint venture and associate line items in the balance sheet masks information that investors find useful for predicting earnings and estimating share prices. However, the similar does not appear to hold for income statement items. Despite only small increases in R-squared values, overall the disaggregate model appears to provide more useful information. The study next investigates the loss of information when joint venture revenues are aggregated with joint venture expenses to give joint venture earnings. The results from estimating equations (7) and (8) are presented in Table 5. These equations also test whether joint venture revenues are statistically different from firm revenues. For this specification, joint venture earnings, OI JV, are disaggregated into REV JV and EXP JV, and firm revenues, REV, are disaggregated from net income. The remaining variables are carried forward as before. Tests of equality on revenue and expense coefficients for REV JV and EXP JV,! 33 ¼! 43 and 33 ¼ 43, are rejected for earnings forecasting and equity valuation for both the Canadian and UK samples (p-values ¼ 0.05 and 0.04 for Canada and 0.01 and 0.05 for UK). The results also show that joint venture revenues are forecasting and valuation relevant, incremental to net income, with t-statistics of 1.69 and 2.31 (2.61 and 1.69) for earnings forecasting and equity valuation, respectively, for Canada (UK). Similarly, joint venture expenses are negatively incrementally forecasting and valuation relevant, with t-statistics of 1.72 and 2.19 ( 2.79 and 1.81) for Canada (UK). Additional tests show that firm revenues and joint 21 The equity value coefficients are consistent on what one would predict based on the persistence coefficients of OI JV and OI AS. The persistence coefficients of NI, OI JV, and OI AS for the Canadian (UK) sample are 0.43, 0.70, and 0.48 (0.38, 0.57, and 0.42), respectively. The higher persistence of OI JV is consistent with it being incrementally valuation relevant over net income. Likewise, the persistence of NI and OI AS are similar in magnitude, consistent with OI AS not being incrementally valuation relevant over NI. 22 Given that the component amounts are relatively small in economic terms one does not necessarily expect to see a large increase in R-squared.

ACCOUNTING FOR JOINT VENTURES 411 Table 5 Summary Statistics from Regression of Future Earnings and Current Share Prices on Net Income, Firm Revenues, Joint Venture Revenues, Joint Venture Expenses, Associate Earnings, and their Equity Book Value Components NI tþ1 ¼! 03 þ! 13 NI t þ! 23 REV t þ! 33 REV JVt þ! 43 EXP JVt þ! 53 OI ASt þ! 63 BV t þ! 73 BV JVt þ! 83 BV ASt þ " 7tþ1 P t ¼ 03 þ 13 NI t þ 23 REV t þ 33 REV JVt þ 43 EXP JVt þ 53 OI ASt þ 63 BV t þ 73 BV JVt þ 83 BV ASt þ " 8t Canada UK NI tþ1 P t NI tþ1 P t Variable Predicted Sign NI þ 0.35 1.87 0.26 2.75 (3.26) (3.85) (4.34) (8.63) REV þ 0.01 0.08 0.02 0.06 (3.19) (3.37) (1.80) (3.76) REV JV þ 0.27 2.32 0.68 2.78 (1.69) (2.31) (2.61) (1.69) EXP JV 0.30 ({2.28) 0.75 2.65 ({1.72) ({2.19) ({2.79) ({1.81) OI AS þ 0.01 1.15 0.41 3.71 ( 0.23) (0.12) (0.64) ( 1.52) BV þ 0.06 0.64 0.05 0.58 (3.18) (5.69) (4.78) (8.42) BV JV þ 0.05 0.45 0.04 1.21 ( 1.62) (1.72) ( 0.04) ({1.71) BV AS þ 0.21 1.12 0.01 1.71 (3.01) ({1.99) 1.01 (1.90) N 300 398 295 424 Adj R 2 0.59 0.55 0.41 0.49 Tests p-value p-value p-value p-value s of REV JV and EXP JV! 33 ¼! 43 33 ¼ 43! 33 ¼! 43 33 ¼ 43 0.05 0.04 0.01 0.05 s of REV and REV JV! 23 ¼! 33 23 ¼ 33! 23 ¼! 33 23 ¼ 33 0.09 0.02 0.02 0.07 Rejecting model in Table 4 in favour of disaggregated model in Table 5 0.00 0.00 0.00 0.27 Notes: P is price per share at fiscal year end. NI is net income of the firm. REV is revenues of the firm excluding joint venture and associate revenues. REV JV is joint venture revenues. EXP JV is joint venture expenses. OI AS is associate earnings. BV is book value of equity at fiscal year end of firm. BV JV is net investment in joint ventures. BV AS is net investment in associates. NI, REV, REV JV, EXP JV,OI AS, BV, BV JV, and BV AS are deflated by number of shares outstanding at fiscal year end. N is number of firm-year observations. t-statistics are based on White (1980) heteroscedasticity-consistent standard errors.

412 SOONAWALLA venture revenues are marginally or significantly different from each other for earnings forecasting and equity valuation for both samples (p-values ¼ 0.09 and 0.02 for Canada and 0.02 and 0.07 for UK). The results from this analysis indicate that aggregating joint venture revenues and expenses into joint venture earnings results in loss of forecasting and valuation relevant information, as evidenced by statistically different coefficients on REV JV and EXP JV. Interestingly, this is the case even though the revenue and expense coefficients appear to be of similar magnitudes, and are highly collinear with opposite signs. As before, the increase in R-squared values from Table 4 to Table 5 is not dramatic. For the forecasting and valuation equations, the R-squared values increase from 0.57 to 0.59, and 0.53 to 0.55 for the Canadian sample. The R- squared value increases from 0.40 to 0.41 for earnings forecasting for the UK sample, but remains the same at 0.49 for equity valuation. The J-test rejects the models in Table 4 in favour of the models in Table 5, for all specifications except equity valuation for the UK sample. Taken together the findings show that there are two levels of potential information loss when reporting interests in joint ventures and associates. The first occurs when joint venture and associate items are aggregated. These results suggest that in reporting regimes where joint venture and associate investment amounts are disclosed only in aggregate, shareholders incorrectly place the same forecasting and valuation multiples on joint venture and associate investment numbers. The second type of loss occurs when joint venture revenues and expenses are aggregated to give joint venture earnings. The results suggest that failure to clearly delineate joint venture revenues and expenses masks information that is forecasting and valuation relevant. 6. SENSITIVITY ANALYSIS (i) Positive and Negative Earnings Samples Prior research finds that valuation estimates differ for firms with positive and negative earnings. This is predictable from the Ohlson model given that negative earnings are less persistent than positive earnings (Hayn, 1995; Collins, Maydew and Weiss, 1997; and Collins, Pincus and Xie, 1999). The findings presented in Tables 3 through 5 are based on all pooled firm-years. Thus, the study re-estimates the earnings forecasting and equity valuation equations, limiting the samples to positive and negative earnings firms. Almost 70% of the Canadian sample and 75% of the UK sample have positive earnings. Untabulated results for the positive earnings samples largely support those presented for the full sample. 23 The results on the loss of information from aggregating joint venture revenues and expenses do not hold for the negative earnings sample of either country. However, it is difficult to interpret too much from the negative earnings results, as these samples are much smaller. 23 The finding of loss of earnings forecasting information from aggregating joint venture revenues and expenses do not hold for the positive earnings Canadian sample.

(ii) Other Sensitivity Analysis ACCOUNTING FOR JOINT VENTURES 413 As part of the sensitivity analysis, equations (3) to (8) are re-estimated replacing net earnings with net abnormal earnings, NI a t, calculated as NI t rbv t 1. 24 For this analysis r is set at 12%, the long-term rate of return on equities (Dechow et al, 1999; and Barth et al., 1999). Use of net abnormal earnings is consistent with Ohlson (1995), who builds a valuation model with net abnormal earnings, book value of equity, and also permits other information. Untabulated results show that the inferences do not change when using net abnormal earnings instead of net earnings. The analyses in Tables 3 through 5 use variables scaled by number of shares outstanding. To check for robustness of results, sensitivity analyses are carried out using undeflated levels data, and also, deflating all variables by total assets as an alternative deflator. Using undeflated variables is consistent with Barth and Kallapur (1996), who argue that including book value of equity as an independent variable, controls for the size problems that scaling attempts to mitigate. Results from these additional analyses are largely consistent with those from using scaled data. One exception is that when using unscaled data, both equality of joint venture and associate earnings, and joint venture and associate investments, for earnings forecasting and equity valuation are rejected for the Canadian and UK samples. The general results also hold when total assets are used as an alternative deflator, with the exception that the equality of joint venture revenues and expenses coefficients for earnings forecasting is rejected with marginal significance for both countries. 25 (iii) Large Sample Sector Comparison In order to provide a richer sample understanding, the study examines large samples of Canadian and UK firms. It looks at industry distributions for the large samples to see whether they are similar to the distributions of the joint venture samples. These large sample distributions are presented in Table 6. This provides an insight into whether the joint venture samples are representative of their national industry distributions. For these comparisons, the entire Canadian and UK databases are obtained from Compustat and allocated in their respective industry sectors. There are some differences between industry distributions for joint venture samples and the whole samples. For instance, the largest group of Canadian joint venture firms is from manufacturing firms at 35%, followed by mining firms at 20%, and transportation and service firms at 8% each. On the other hand, mining firms represent the largest group of the entire Canadian database at 30% of the whole sample, followed by manufacturing firms at 28%, and financial firms at 15%. For the UK, manufacturing and financial firms constitute the two largest groups for both the joint venture and large samples (30% and 24 Under this specification it is no longer necessary to include dividends per share as an independent variable, because presence of lagged book value of equity on the right hand side serves a similar purpose. 25 Finally, the study also looks at distributions of earnings and equity book value components to previous period price to check for extreme observations. This check is done for the whole sample, including the previously winsorised extreme 1% observations. On deleting observations where the R-student values are greater than 2.5, the results are similar to those obtained in the main analysis.

414 SOONAWALLA Table 6 Large Sample Industry Sector Membership Canada UK Industry SIC Codes No. of Firms % No. of Firms % Agriculture 0000 0999 7 0.42 13 0.76 Mining 1000 1499 511 30.49 40 2.33 2900 2999 Construction 1500 1999 11 0.66 67 3.90 Manufacturing 2000 2899 464 27.68 526 30.60 3000 3999 Transportation 4000 4899 82 4.89 68 3.96 Utilities 4900 4999 48 2.86 36 2.09 Retail/Wholesale 5000 5999 101 6.03 231 13.44 Financial 6000 6999 253 15.10 460 26.76 Services 7000 8999 187 11.16 278 16.17 Public Admin 9000 9999 12 0.72 Total 1,676 100.00 1,719 100.00 16% for the joint venture sample, and 30% and 27% for the large sample). This is followed by transportation for the joint venture sample at 11%, and services for the large sample at 16%. In contrast, the UK joint venture sample has fewer services firms. Despite these differences in industry distribution, there are similarities between the joint venture sample and the larger sample. The persistence coefficient on net income is very similar for both groups of firms. Untabulated net income autoregression equations reveal that the net income persistence coefficients are 0.53 and 0.58 for the Canadian joint venture and large samples, respectively. The net income persistence coefficients are 0.68 and 0.70 for the UK joint venture and large samples, respectively. 26 For this autoregression equation the predictor variables are lagged net income and lagged shareholders equity. 27 Although the large UK sample appears to have higher net income persistence coefficient than the Canadian sample, these differences do not hold for the respective joint venture samples, where net income persistence coefficients are similar in magnitude. The results in Tables 3 through 5 indicate that, given the various joint venture and associate earnings components, net income persistence is similar in both countries. 7. SUMMARY AND CONCLUDING REMARKS This study provides evidence that aggregating joint venture and associate investment numbers results in loss of forecasting and valuation relevant information. It also predicts and finds that joint venture revenues and expenses are significantly 26 These persistence coefficients are obtained using unscaled data. This is because Compustat does not provide number of shares outstanding for the UK sample. 27 The equation used for this is NI tþ1 ¼ þ NI t þ BV t þ tþ1.

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