"Permanent Earnings of Industrial Firms in Japan --Part I A Cross ] Sectional Analysis (3) --" (in Japanese)

The main purpose of this research is to investigate the rationality of current form of income measurement and reporting in Japan. In this paper, net income is divided into three components: 1) operating profits, 2) gains and losses from non-core operating activities and financial activities, and 3) other gains and losses (taxes and gains and losses from unusual activities). This research investigates whether, given operating profits, other two components have explaining power for the variation of stock prices. The empirical results show that other two components are value relevant and each has indigenous information contents. Therefore, current rule in Japan, which mandates to divide net income into those components and report them separately, has rationality. However, gains and losses from non-core operating activities and financial activities are not independent earnings that have the complete meanings. The results seem to support the view that it could gain empirical meanings only by being added to operating profits and integrated into ordinary income (net income). As reported in our prior research, controlling the noisy factors contained in the components makes earnings information more value relevant. By testing the relevance of earnings components with controlling noises, this research confirms the potential information value of earnings as original data set, which investors process for estimating permanent earnings of firms.