Accounting & Marketing

Stock Volatility Consequences when Using the Equity Method in Parent Company

Abstract

Schøler F

This paper contributes to the recent literature on the information transparency and its impact on stock price volatility. Some authors claim that more disclosure might reduce volatility of the stock price. Since 2005 the use of IFRS is mandatory for listed companies in the EU. In some countries, like Demark, corporate law allows the use of the Equity Method in separate financial statements to measure investments in subsidiaries, which is contrary to IFRS. Lately, IFRS has re-allowed the use of the Equity Method (probably to be approved by the EU soon). This study investigates the stock volatility consequences of using the Equity Method so far in Denmark. We had collected all Danish non-financial and non-insurance companies disclosing consolidated Group and Parent company financial statements. Also, we selected volatility measures by use of the ORBIS-database, and analyses it all together. Our tests showed lower level of volatility for the Equity Method using group of companies compared to the non-Equity method using group of companies, also after controlling for differences in industries and transparency levels in the two groups’ companies. Regression analyses confirmed the tendency that Equity Method and lower volatility follows each other. However, we did not find evidence that the specific account “Reserve for net Revaluations under the Equity Method” should be a significant part of the relation. It seems that most important for the size of the volatility is the difference between consolidated Group Equity and Parent Equity. However, whether a smaller difference stems from a relatively high part of group income being realized in parent’s financial statements, or whether it stems from relatively high part of group income being recognized in subsidiaries by use of the Equity Method seems not to be important.