Differences in the valuation of earnings and book value: Regulation effects or industry effects?

This paper uses a valuation framework on a sample of firms from four European countries (France, Germany, Netherlands, and United Kingdom) to examine how income, accruals, and book value of equity are perceived by the respective capital markets. Our model includes adjustments for industry effects and taking into account the linear information dynamics of the accounting variables posited in the Ohlson model. Consistent with previous researchers, we find that both earnings and book value of equity have valuation implications and that there is significant dispersion in the country-specific and industry-specific valuation multiples. However, when using accounting variables to forecast market values we find that industry-specific valuation multiples reduce forecasting error more than country-specific ones.     

Modeling dividends,earnings, and book value equity: An empirical investigation of the ohlson valuation dynamics

This study empirically investigates the information dynamics of the Ohlson valuation framework. Single-period lagged linear autoregressive relationships among dividends, earnings, and book values of equity are estimated for a sample of stochastically stationary firms and are found not to support the valuation framework. This study further extends the empirical analysis to a multilagged vector autoregressive linear information system. Consistent with the Ohlson valuation framework,the past time series of all three variables are generally found to be relevant for firm valuation. This study brings into question empirical research utilizing the Ohlson framework that presupposes a single-period lagged information dynamic.     

Consistency,Value Relevance and Sufficiency of Book for Market Values in Five Japanese Conglomerates Over the Period 1950–2004

Market and accounting data for five Japanese conglomerates, Toyota, Fuji, Sony, Itochu and Sumitomo, are analysed over the period 1950 to 2004. Annual market value is regressed on three accounting and six macroeconomic variables, using a general‐to‐specific approach to construct simple error correction models for each of the five firms. The results show that in four of the five firms there is evidence of a long‐run relationship between market value and the net book value of assets, which can be interpreted, with increasing degrees of strength, as book values being either consistent with, value relevant for, or sufficient for market value.     

Linear Information Dynamics,Dividend Irrelevance,Corporate Valuation and the Clean Surplus Relationship

This paper adopts the linear information dynamics framework pioneered in Ohlson (1979) and Garman and Ohlson (1980) (and subsequently used in, in particular, Ohlson, 1989, 1995 and Feltham and Ohlson, 1995) for thinking about desirable properties of earnings numbers in the context of the market valuation of firms, where such valuations are fundamentally based on expected future dividends. The first purpose of this paper is to consider the valuation-relevance of clean surplus earnings when there are two distinct components of clean surplus earnings whose evolutions are governed, along with book value and dividends, by a system of linear information dynamics, and dividend irrelevancy holds. The system of linear information dynamics assumed ensures that corporate value is a linear combination of the two components of clean surplus earnings, book value and dividends. One question becomes—under what circumstances are clean surplus earnings (combined with book value and dividends) sufficient for corporate valuation without a knowledge of the breakdown of clean surplus earnings into its separate components? This paper develops the conditions defining these circumstances. At the other extreme, another question can be asked—under what circumstances is one component of clean surplus earnings irrelevant to corporate valuation? This paper identifies some conditions that identify these latter circumstances. The second purpose of the paper is to identify implications of these results for both the traditional arguments about the desirability of measuring earnings on a clean surplus basis and also the more contemporary issues surrounding FRS3. A third purpose is to discuss the implications of the overall analysis for the empirical testing of the relationship between market prices and earnings numbers, and for empirically-justified definitions of maintainable earnings.     

Does market misvaluation help explain share market long‐run underperformance following a seasoned equity issue?

We examine the relation between pre‐seasoned equity offering (SEO) announcement date misvaluation and long‐run post‐SEO performance for a large sample of Australian SEOs made between 1993 and 2001. Our study is motivated by inconsistent findings across countries with respect to the SEO long‐run underperformance anomaly first documented in the USA, inconclusive findings with respect to the hypothesis that managers exploit market misvaluation when timing equity issues, and a recent Australian Stock Exchange proposal to loosen SEO regulation. We find SEO firms underperform common share market benchmarks for up to 5 years after the announcement. Using a residual income valuation method, we show that this underperformance is related to pre‐announcement date misvaluation. An unexpected result is that underperformance and misvaluation are more severe for private placements than rights issues. Institutional factors unique to the Australian setting, particularly the large number of smaller loss‐making firms among private placement issuers, appear to explain the poorer performance of placement firms. Our results are robust to various measurement methods and assumptions, and demonstrate the importance of researching SEO performance in alternative institutional settings.     

Payout Policy Relevance and Accounting‐based Valuation

DeAngelo and DeAngelo (2006) (D&D) argue ‘payout policy is not irrelevant and investment is not the sole determinant of value, even in frictionless markets’. Consistent with this view, we argue that the concept of a perfect capital market in Miller and Modigliani (1961) (M&M) and Fama and Miller (1972) can be extended to allow for managerial moral hazard if managers are assumed not to participate in securities trading. An updated version of the M&M valuation model is presented and the possibility of managerial free cash flow (FCF) retention through operating expense manipulation and sub‐optimal investment policies is discussed. Our analysis supports D&D's argument that payout policy is relevant and indicates that value relevance of payout depends on the quality of earnings measurement and the optimality of investment policy. Following this, we develop a framework for analyzing valuation and informational roles of payout in accounting‐based valuation models and apply this framework to the Ohlson (1995) and Feltham and Ohlson (1996) models. This analysis shows how these models permit payout valuation relevance due to managerial FCF retention but not payout informational relevance. Finally, we consider how the Feltham and Ohlson (1996) model can be extended to incorporate time variation in expected profitability of capital investment caused by time variation in managerial FCF retention activities and show that this explicitly affects payout value relevance. We conclude that the development of models where payout plays an explicit valuation role due to issues of moral hazard is an important direction for future research.     

The Sophisticated and the Simple: the Profitability of Contrarian Strategies

A variety of variables have been used to form contrarian portfolios, ranging from relatively simple measures, like book‐to‐market, cash flow‐to‐price, earnings‐to‐price and past returns, to more sophisticated measures based on the Ohlson model and residual income model (RIM). This paper investigates whether: (i) contrarian strategies based on RIM perform better or worse than those based on the Ohlson model; (ii) contrarian strategies based on more sophisticated valuation models (e.g. Ohlson and RIM) perform much better than the relatively simpler ranking variables that have been used so extensively in the finance literature. Given that the RIM and Ohlson models require greater information inputs and technical know‐how, and make different implicit assumptions on future abnormal earnings, it is important to ascertain if they offer significantly greater contrarian profits to outweigh the increased costs that they entail. Indeed, our surprising finding is that simple cash flow‐to‐price measures appear to do almost as well as the more sophisticated alternatives. One would have expected the sophisticated models to significantly outperform the simple cash flow to price model for the reasons given by Penman (2007) .     

The Cost of Carbon: Capital Market Effects of the Proposed Emission Trading Scheme (ETS)

In March 2008, the Australian Government announced its intention to introduce a national Emissions Trading Scheme (ETS), now expected to start in 2015. This impending development provides an ideal setting to investigate the impact an ETS in Australia will have on the market valuation of Australian Securities Exchange (ASX) firms. This is the first empirical study into the pricing effects of the ETS in Australia. Primarily, we hypothesize that firm value will be negatively related to a firm's carbon intensity profile. That is, there will be a greater impact on firm value for high carbon emitters in the period prior (2007) to the introduction of the ETS, whether for reasons relating to the existence of unbooked liabilities associated with future compliance and/or abatement costs, or for reasons relating to reduced future earnings. Using a sample of 58 Australian listed firms (constrained by the current availability of emissions data) which comprise larger, more profitable and less risky listed Australian firms, we first undertake an event study focusing on five distinct information events argued to impact the probability of the proposed ETS being enacted. Here, we find direct evidence that the capital market is indeed pricing the proposed ETS. Second, using a modified version of the Ohlson ( 1995 ) valuation model, we undertake a valuation analysis designed not only to complement the event study results, but more importantly to provide insights into the capital market's assessment of the magnitude of the economic impact of the proposed ETS as reflected in market capitalization. Here, our results show that the market assesses the most carbon intensive sample firms a market value decrement relative to other sample firms of between 7% and 10% of market capitalization. Further, based on the carbon emission profile of the sample firms we imply a ‘future carbon permit price’ of between AUD$17 per tonne and AUD$26 per tonne of carbon dioxide emitted. This study is more precise than industry reports, which set a carbon price of between AUD$15 to AUD$74 per tonne.     

The Effect of Ultimate Ownership on the Disclosure of Environmental Information

This study empirically examines whether environmental information disclosure (EID) is influenced by the characteristics of a firm's ultimate owners. Based on the EID of publicly listed firms in China, we qualitatively measure the quality of EID of each firm and link those quality scores to firm characteristics to understand the determinants of EID. We further link the EID scores to market valuation of the firm through the Ohlson valuation model to understand whether the market appreciates EID. Our results show that EID is more likely for government‐controlled firms, firms with less hierarchy in their ultimate ownership and firms with more discrepancy between voting rights and cash flow rights. Our results also indicate that the stock market appreciates environmental issues and that EID itself, as well as disclosure quality, is associated with a higher market valuation. Our results still hold with the endogeneity issue controlled.     

Non‐additivity in Accounting Valuation: Theory and Applications

This paper has three objectives. First, to introduce a theoretical solution to the issue of non‐additivity between assets in place, relying on an accounting‐based valuation approach. Second, to explain how such an approach can be implemented empirically by measuring synergies between assets. Third, to present the properties of this non‐additive valuation technique. We use Choquet capacities, that is, non‐additive aggregation operators, to measure the interactions between assets and apply our methodology to a sample of US firms from the capital goods industry. To operationalize our approach we examine the relationships between synergies—captured by Choquet capacities—and the market‐to‐book ratio (proxying for growth options), and show how interactions between assets are consistently linked to a firm’s market‐to‐book ratio. We also measure firm‐specific productive efficiency relative to the industry and firm size. For large firms, efficiency, as defined by our approach, is positively associated with higher future operating cash flows. For small firms, efficiency is positively associated with higher future sales growth. We document that the non‐additive approach appears to be better able to identify expected relationships between efficiency and future performance than a simpler approach based on the market‐to‐book ratio.     

A fractional cointegration approach to testing the Ohlson accounting based valuation model

We examine the long-run relationship between market value, book value, and residual income in the Ohlson (Contemp Acc Res 11(2):661–687, 1995) model. In particular, we test if market value is cointegrated with book value and residual income in light of their non-stationary behaviors. We find that cointegration applies to only 51 % of the sample firms, casting doubt that book value and residual income alone are adequate in tracking variations in market value, yet we find that market value is fractional cointegrated with book value and residual income for 89 % of the sample firms. This implies that the long-run relationship follows a slow but mean-reverting process. Our results therefore support the Ohlson model.     

Financial Distress and the Cross‐section of Equity Returns

We explicitly consider financial leverage in a simple equity valuation model and study the cross‐sectional implications of potential shareholder recovery upon resolution of financial distress. Our model is capable of simultaneously explaining lower returns for financially distressed stocks, stronger book‐to‐market effects for firms with high default likelihood, and the concentration of momentum profits among low credit quality firms. The model further predicts (i) a hump‐shaped relationship between value premium and default probability, and (ii) stronger momentum profits for nearly distressed firms with significant prospects for shareholder recovery. Our empirical analysis strongly confirms these novel predictions.     

An Ohlson valuation framework for valuing corporate governance: The case of Taiwan

We examine the relation between a firm's market value, financial performance, and corporate governance as a cointegrated system in the Ohlson (1995) valuation framework. Using a comprehensive set of 29 governance measures in 4 categories for Taiwanese firms, we find that governance related to ownership structure and divergence between cash flow rights and control rights are important for a firm's market valuation. In particular, information about shareholdings of board directors and supervisors, shareholdings of controlling family, and voting rights are influential for firm value. Controlling for book value and residual incomes in the model, these governance measures track much of the remaining firm valuation that is unrelated to a firm's financial performance. Our findings provide some insight into the intrinsic value of corporate governance and the types of corporate governance mechanisms that are especially important for firms with similar ownership structure and controls.     

Valuation of Family Firms: The Limitations of Accounting Information

This conceptual paper explores the extent to which reported accounting information captures unique family firm decision‐making and intangible asset factors that impact financial value. We review the family firm valuation‐relevant literature and identify that this body of research is predicated on the assumption that accounting information reflects the underlying reality of family firms. This research, however, fails to recognise that current accounting technology does not fully recognise the family firm factors in the book value of the firm or the implications for long‐run persistence of earnings. Thus, valuation models underpinning the extant empirical research, which are predicated on reported accounting information, may not fully reflect the intrinsic value of family firms. We present propositions on the interaction between accounting information, family factors and valuation as a road map for future empirical research with a discussion of appropriate methodologies.     

The Value Relevance of International Financial Reporting Standards: Empirical Evidence in an Emerging Market

This study examines the value relevance of accounting information under International Financial Reporting Standards (IFRS) in the Abu Dhabi Stock Exchange (ADX, henceforth). Based on models developed by Easton and Harris (1991), and Ohlson (1995) and using monthly market data from 2000 to 2006, this paper investigates the value relevance of accounting information of firms traded on the ADX. Our overall results show that earnings scaled by beginning of period price are positively and significantly related to cumulative returns and that earnings per share and book value per share are positively and significantly related to price per share. We also find that value relevance of accounting information has changed since the market inception in 2000. The results documented herein extend the literature on value relevance accounting information in an emerging market that requires the use of IFRS. The study therefore contributes to the debate over the mandatory adoption of IFRS and the value relevance of accounting information reported under IFRS.     

An empirical assessment of the Feltham-Ohlson models considering the sign of abnormal earnings

This paper provides an empirical assessment of the Feltham-Ohlson models, distinguishing between firms with positive and negative abnormal earnings. Abnormal earnings persistence and conservatism parameters differ for these two groups; this implies different earnings prediction models and valuation functions for both profit-making and loss-making firms. The analysis refers to the period 1991-1999 and uses a sample of Spanish firms quoted on the Madrid S.E. The results suggest that our contextual approach is more useful than the non-contextual one to predict future abnormal earnings and explain current prices. Although the Ohlson (1995) model is accurate in forecasting future abnormal earnings and stock prices, the results improve when firms with negative abnormal earnings are valued using a temporary model and firms with positive abnormal earnings using a more permanent one. The Feltham and Ohlson (1995) model generates the lowest forecast errors in the prediction of positive abnormal earnings, but it produces the least accurate results in forecasting prices.     

Towards an understanding of profitability analysis within the residual income valuation framework

This paper argues that there is a mis-match between formal theoretical accounting valuation models, and practical approaches to profitability analysis and valuation. In particular, none of the linear information models published to date exhibit an obvious role for profitability analysis. For example, in the standard Ohlson model, earnings and book value apparently summarise all the value relevant information available from the firm's financial statements and there is no apparent need for any further investigation of the accounting numbers beyond these specific line items. The purpose of this paper is to attempt to investigate potential analytical links between formal valuation models and practical profitability analysis. Specifically, we attempt to show how key features of practical profitability analysis might be incorporated into formal valuation models. In this respect there are two particular aspects of valuation practice to which the formal models published to date have paid no attention. First, in practice we often see explicit reference made to the demand side (sales), and supply side (costs) of the business. Second, we often see attempts to benchmark the financial ratios of one firm against the corresponding ratios of firms in the same industry. The purpose of this paper is to attempt to explain why such practices make sense in the context of an attempt to model the principal determinants of firm value within a residual income valuation framework.     

Dividends,research and development expenditures,and the value relevance of book value for UK loss-making firms

We extend prior research on the value relevance of accounting information for loss-making firms by allowing the coefficient of book value to vary across three distinct set of loss-making firm observations in our valuation model. Our key findings are, first, that book value is a less important determinant of equity value for either high R&D-intensive firms or dividend-paying firms, relative to firms with low R&D-intensity and zero dividends. Prior literature suggests that book value is a strong indicator of firm value for loss-making firms. This reasoning stems from book value's role as: (i) a proxy for the value of the possibility of abandoning or adapting the firms' net assets; and/or (ii) a proxy for expected future normal earnings. Our work suggests that this prior literature does not fully capture the valuation role of book value for loss-making firms. Second, we also find that dividends are value relevant, but generally only when the valuation role of book value is contextualised by allowing its coefficient to vary across high R&D-intensive firms, and dividend-paying, loss-making firms.     

Value versus growth: Australian evidence

The value‐growth effect is one of the most pervasive patterns in stock prices. In this study, the ability of four proxies for value‐growth, book‐to‐market, sales‐to‐price, earnings‐to‐price and cash‐flow‐to‐price to explain equity returns is analysed. The findings show that in aggregate, book‐to‐market best explains cross‐sectional variation in Australian equity returns, which in isolation suggests that it is the superior proxy for value‐growth. The analysis is taken further and the value‐growth effect is examined separately in positive and negative earnings firms. After segregating firms, it is found that in the negative earnings sample, book‐to‐market is the best value‐growth proxy and in the positive earnings sample, cash‐flow‐to‐price has the highest level of significance and is thus the superior value‐growth proxy. The economic significance of this result is telling, as the firms that report positive earnings are much larger than those that report negative earnings.     

Profitability,Value, and Stock Returns in Production‐Based Asset Pricing without Frictions

In a production‐based asset pricing model without adjustment costs and with decreasing returns to scale following Brock (1982), stock returns at the firm level are determined by profitability, the book‐to‐market ratio, and the change in future profitability prospects. Although firms with low book‐to‐market ratios are normally more profitable and profitable firms are predicted to have higher returns, the stylized fact that book‐to‐market ratios positively forecast returns still holds theoretically, but with specific predicted exceptions. These implications are confirmed empirically.