Cutting Through Complexity: Segment Disclosure and Pricing Efficiency

In 1997, Statement of Financial Reporting Standards (SFAS) 131 introduced a substantial change in how segment information is reported in US-GAAP (Generally Accepted Accounting Principles) financial statements. We seek to examine whether this change in financial reporting policy increases investors' ability to process information relevant to conglomerate firms (i.e., those operating in multiple industries) more quickly, and whether this increased efficiency in information processing varies cross-sectionally based on firm complexity and the direction of industry news. Our results indicate that SFAS 131 has increased the speed with which stock prices capture information about conglomerates, relative to focused firms, although we find that some frictions remain with regard to disclosing bad news. This study documents an example of how a change in disclosure policy can enhance pricing efficiency, and hence, it may be of interest to the Financial Accounting Standards Board (FASB) in its ongoing initiative to consider potential changes to SFAS 131.