Functional Currency: Effects on Earnings and the Market.

This article presents an abstract of Patricia Marie Poli's, dissertation, Functional Currency: Effects on Earnings and the Market. This study investigates whether or not the use of different functional currencies affects the quality of earnings and related capital market activity of U.S.-based multinational corporations. The study shows that the aggregate earnings response coefficients are lower and the earnings streams are more volatile and less permanent for companies using the U.S. dollar as the functional currency and that the foreign currency adjustments do not fully explain the different earnings response coefficients even though they are a transitory component of earnings. When earnings are further disaggregated into their foreign and domestic components, companies using the U.S. dollar as the functional currency have less permanent earnings streams for these two components. However, the earnings response coefficients of the two groups are not different for either component. It is concluded that the translation adjustment should not be reported on the income statement because it is a transitory component of earnings and is associated with lower earnings response coefficients. It is also suggested that use of the U.S. dollar as the functional currency motivates companies to make other non-optimal economic decisions that obscure the true earnings results.