The Effects of SFAS 131 Geographic Segment Disclosures on the Valuation of Foreign Earnings

Thomas (1999) documents that investors discount the value of foreign earnings for U.S. multinationals. He conjectures but does not test the possibility that this finding is due to poor disclosure related to foreign operations. In this paper, we investigate whether the market's valuation of foreign earnings is a function of the firm's geographic segment disclosures. Specifically, we examine the effects of (1) the introduction of SFAS 131,(2) the change in the number of geographic segments disclosed, and (3) the inclusion of performance measures in geographic segment disclosures. We find strong evidence that our proxies for increased disclosure are positively associated with the foreign earnings response coefficient (FERC). We further find that increases in the number of geographic segments are incrementally value relevant beyond other SFAS 131 disclosures. Similarly, inclusion of earnings in geographic segment disclosures has an incremental effect on FERC beyond both SFAS 131 per se and a change in the number of geographic segments. In addition, we use the Mishkin (1983) test and find that investors' mispricing of the foreign component of earnings lessens (and in fact disappears) with greater disclosure related to foreign operations. Taken together, our results suggest that the pricing of foreign earnings is associated with important aspects of the firm's information environment.