Earnings Management REPORTING COMPREHENSIVE INCOME AND MANAGERIAL

536 Considering this as background, most of the early empirical researches on reporting financial performance were value-relevance style researches and they concluded that the value-relevance of net income was stronger than that of comprehensive income. On the other hand, there are few researches which analyzed the relation between comprehensive income reporting and earnings management for net income. Thinking of it, the open question whether comprehensive income reporting functions as it is expected or not still remains. 2. Review There are several researches on the relation between earnings management and reporting comprehensive income 75 . These researches provided evidence that comprehensive income is less likely to be affected by earnings management than net income. However, we can say there are still some open questions. The reasons are as follows. First, most of these researches include comprehensive income and its components that are calculated artificially, not ones that are titled in income statement as they are. There is a possibility that managers behave in the same way if the reporting format of financial statement does not change substantively. Considering this, these research results do not reflect the change of managers‘ behavior even if it happens. Second, they focused only on net income and comprehensive income, not on the relation between them other comprehensive income. To consider whether comprehensive income reporting works as standard-setters expected, it is necessary to analyze earnings management for net income more specifically, the relation between other comprehensive income and net income. Therefore this implies that it is still unclear how managers manage net income by controlling other comprehensive income after introducing comprehensive income reporting. The original purpose of the reporting financial project is to improve the transparency of reporting financial performance and to prevent earnings management for net income. In this respect, whether the effect of introducing comprehensive income reporting works well or not is still not clear.

3. The Relation between Other Comprehensive Income and Net Income

Generally, there are two types of earnings management. One is changing accounting policies for manipulating earnings. The other is changing business activities or contracts and then managing earnings. Thinking of the relation between other comprehensive and net income, we will need to consider the latter type. That is, if managers want to increase or decrease their net income, they will turn other comprehensive income items =unrealized gains into realized gains and losses by selling available-for-sale securities, subsidiaries abroad or settling cash flow derivatives, etc. Some of the researches above pointed out that managers have motivation for managing net income by realizing other comprehensive income. However, the previous researches above do not analyze this behavior of managers by using actual other comprehensive income numbers. Therefore, in this paper we will examine the manipulation of net income by realizing other comprehensive income items with actual other comprehensive income numbers before and after introducing reporting comprehensive income reporting. 75 Hirst et al.1998, Hutton et al.2004, Lee et al.2004, Satoh and Nakagawa2006 and Wakabayashi2006. 537

4. Samples and Research Hypothesis

1 Samples In this research, samples firm years are selected according to criterions as follows. Firms in Tokyo stock exchange group 1 st section adopting SEC standards. The period for the analysis is from 1995 to 2007. Comprehensive income reporting was introduced from 1999 substantially in sample firms. Firm years when total asset, net income, unrealized gains and losses related to sale available security and its reclassification 76 item are available in the annual reports during 1995~2007. Firm years when unrealized gain and losses on exchange translation differences on foreign currency net investment and its reclassification is available in annual reports during 1999-2007. Firm years when unrealized gains and losses on cash flow hedge derivatives and its reclassification is available in annual report during 2002-2007. Inputting these samples with manual procedure 2 Research Hypothesis If managers think the transparency of financial performance is enhanced by comprehensive income reporting, it is presumed that the manipulation of net income by using other comprehensive income decreases after the period when introducing the comprehensive income reporting. Especially, according to FAS130, it was expected that the introduction of reporting comprehensive income would improve the traceability from other comprehensive income to net income =recycling or reclassification. Considering these aspects, more specifically, we present the following hypotheses. H: the magnitude of earnings management for net income by using other comprehensive income items scales down after the period when adopting comprehensive income reporting. 3 Research Model We examine the hypothesis by the following two methods. T-test for the average of reclassification items=realized gains and lossesrelated to other comprehensive income We calculated the percentage of the reclassification of available-for-sale-securities in net income Av1 i , turned the numbers to absolute value and conducted the t-test whether the difference|Av1 i -Av1 i-1 | of the averages was statistically significant or not after period when comprehensive income reporting was introduced1999~2007. Additionally for the period of 1999~2007, we also conducted the same test for the reclassification of exchange translation differences on foreign currency net investment |Av2i-Av2i-1|, and during the years 2002~2007 for the reclassification of cash flow hedge derivatives |Av3 i -Av3 i-1 |. Av1 i =|reclassification of available-sale-security i||net income i | Av2 i =|reclassification of exchange translation differences on foreign currency net investment i ||net income i | 76 Reclassification is a procedure in which other comprehensive income items, when turned into realized items, are charged to net income from other comprehensive income.