CONSERVATIVE ACCOUNTING PRINCIPLES, EQUITY VALUATION AND THE IMPORTANCE OF VOLUNTARY DISCLOSURES

Previous theoretical research on voluntary disclosures has commonly viewed accounting information as a simple signalling device, for example indicating «good news» or «bad news». In this paper, voluntary disclosures are considered to provide complementary information in fundamental valuation analysis, as broadly outlined in Ohlson (1989), Brief & Lawson (1992) and Bernard (1993). The research questions are concerned with the importance of voluntary disclosures in a valuation framework of this kind and the expected content and context of such disclosures. The results imply that voluntary disclosures for typical operating companies are expected to be concerned with the prediction of net income for the next period, the long-run future development of the book return on owners» equity, and the accounting cost matching bias of owners» equity. The cost matching bias is caused by conservative valuation principles, and a specific linkage between the book return and the cost matching bias of owners» equity is recognized in the analysis.     

Accounting‐Based Probabilistic Prediction of ROE,the Residual Income Valuation Model and the Assessment of Mispricing in the Swedish Stock Market

Using Swedish stock market data, this study investigates whether an investment strategy based on publicly available accounting information can generate abnormal investment returns. The strategy involves two steps. First, an accounting‐based probabilistic prediction model of changes in the medium‐term book return on owners' equity (ROE) is estimated. Second, market expectations of changes in medium‐term ROE are assessed through observed stock prices and the residual income valuation model. Stock market positions over 36‐month holding periods are taken when the accounting‐based predictions of ROE and the market expectations differ. Over the period 1983–2003, the investment strategy generated values of Jensen's alpha corresponding to an average monthly excess return for a hedge position of up to 0.8% for a sample of manufacturing companies. In the main this hedge return was caused by strong positive returns to the long positions, and additional analyses show that the returns appear to have been affected by a positive market sentiment bias (i.e., positive ROE surprises being associated with stronger price reactions than negative ROE surprises) making out‐of‐sample inferences somewhat dubious. Furthermore, most of the investment returns accrued over holding periods up to around 1995, with no indications of market mispricing over the last third (1995–2003) of the investment period. The empirical results are consistent with market investors having become more sophisticated in their use of publicly available accounting information over time.