Earnings Components, Accounting Conservatism and Equity Valuation PDF Download
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Author: Peter F. Pope
Publisher:
ISBN:
Category :
Languages : en
Pages : 35
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Book Description
In this paper we address three issues in accounting-based equity valuation: (i) How are valuation parameters related to earnings persistence and accounting conservatism when earnings components aggregate, or add up, in valuation? (ii) What does aggregation of earnings components in valuation imply for abnormal earnings dynamics? and (iii) When is an earnings component irrelevant and core earnings the relevant construct for valuation? Assuming linear valuation, no-arbitrage, dividend irrelevance and clean surplus accounting, we show that when earnings components aggregate, valuation expressions and abnormal earnings dynamics are generalizations of the Ohlson (1995) model, incorporating simple adjustments for accounting conservatism. When core earnings is the relevant earnings construct, valuation expressions closely resemble the aggregation case, but core (abnormal) earnings replaces clean surplus (abnormal) earnings. We demonstrate that an earnings component can be irrelevant in valuation even when it is predictable.
Author: Peter F. Pope
Publisher:
ISBN:
Category :
Languages : en
Pages : 35
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Book Description
In this paper we address three issues in accounting-based equity valuation: (i) How are valuation parameters related to earnings persistence and accounting conservatism when earnings components aggregate, or add up, in valuation? (ii) What does aggregation of earnings components in valuation imply for abnormal earnings dynamics? and (iii) When is an earnings component irrelevant and core earnings the relevant construct for valuation? Assuming linear valuation, no-arbitrage, dividend irrelevance and clean surplus accounting, we show that when earnings components aggregate, valuation expressions and abnormal earnings dynamics are generalizations of the Ohlson (1995) model, incorporating simple adjustments for accounting conservatism. When core earnings is the relevant earnings construct, valuation expressions closely resemble the aggregation case, but core (abnormal) earnings replaces clean surplus (abnormal) earnings. We demonstrate that an earnings component can be irrelevant in valuation even when it is predictable.
Author: Richard P. Brief
Publisher: Routledge
ISBN: 113560942X
Category : Business & Economics
Languages : en
Pages : 324
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Book Description
First published in 1996. The relationship between the present discounted value of future cash flows and discounted excess earnings should be viewed as a mathematical property of a double-entry book[1]keeping system based on clean surplus. The purpose of this anthology is to facilitate future research by highlighting these historical developments and by showing how more recent theoretical and empirical research fits into the earlier history. The book is divided into four sections: historical overview; analytical properties of clean surplus; the theory of the clean surplus equation; and empirical implications.
Author: David J. Ashton
Publisher:
ISBN:
Category :
Languages : en
Pages : 32
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Book Description
In this paper we develop a general framework for evaluating the impact of conservative accounting on the structure of residual income models of equity valuation. This affords a theoretical understanding of the signs and sizes of the valuation weights observed in regression studies of the relationship between prices, book values, earnings and dividends. We proceed to generalize our model of conservatism and are able to show theoretically the likely numerical impact of conservatism on book values, price-earnings ratios and under valuations produced by residual income models. The analysis also affords an understanding of the limitations of empirical investigations of conservatism using linear information dynamics and hence to explain the failure of many such studies to detect conservatism.
Author: D. Eric Hirst
Publisher: Wiley
ISBN: 9780943205496
Category : Business & Economics
Languages : en
Pages : 80
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Book Description
Hirst and Hopkins guide analysts to a comprehension of how income statements and other disclosures can be used to assess the underlying quality and persistence of companies' economic conditions.
Author: Jennifer Francis
Publisher: Now Publishers Inc
ISBN: 1601981147
Category : Business & Economics
Languages : en
Pages : 97
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Book Description
This review lays out a research perspective on earnings quality. We provide an overview of alternative definitions and measures of earnings quality and a discussion of research design choices encountered in earnings quality research. Throughout, we focus on a capital markets setting, as opposed, for example, to a contracting or stewardship setting. Our reason for this choice stems from the view that the capital market uses of accounting information are fundamental, in the sense of providing a basis for other uses, such as stewardship. Because resource allocations are ex ante decisions while contracting/stewardship assessments are ex post evaluations of outcomes, evidence on whether, how and to what degree earnings quality influences capital market resource allocation decisions is fundamental to understanding why and how accounting matters to investors and others, including those charged with stewardship responsibilities. Demonstrating a link between earnings quality and, for example, the costs of equity and debt capital implies a basic economic role in capital allocation decisions for accounting information; this role has only recently been documented in the accounting literature. We focus on how the precision of financial information in capturing one or more underlying valuation-relevant constructs affects the assessment and use of that information by capital market participants. We emphasize that the choice of constructs to be measured is typically contextual. Our main focus is on the precision of earnings, which we view as a summary indicator of the overall quality of financial reporting. Our intent in discussing research that evaluates the capital market effects of earnings quality is both to stimulate further research in this area and to encourage research on related topics, including, for example, the role of earnings quality in contracting and stewardship.
Author: Xiaojun Zhang
Publisher:
ISBN:
Category :
Languages : en
Pages : 256
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Book Description
Author: Pengguo Wang
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
In this paper, we develop a framework for evaluating the impact of conservative accounting on the structure of residual income models of equity valuation. We explore specific examples of both unconditional and conditional conservatism and observe a common mathematical structure. We proceed to generalise our model and identify the joint dependency of conservatism and the persistence of abnormal earnings on the weights attached to book values, earnings and dividends. We are able to show theoretically the likely numerical impact of conservatism on price-earnings ratios and under valuations produced by residual income models. We investigate empirically the interaction between conservatism and persistence and find they accord well with the theory developed. We briefly discuss the implications for testing of the effect of conservatism on valuation and linear information dynamics.
Author: Andreas A. Charitou
Publisher:
ISBN:
Category :
Languages : en
Pages : 50
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Book Description
Author: Guochang Zhang
Publisher:
ISBN:
Category :
Languages : en
Pages : 39
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Book Description
This study develops an accounting-based valuation model in a setting where firms have the flexibility to expand or discontinue operations (real options). The model is used to examine the role of accounting earnings and book value in equity valuation and to explore cross-sectional differences in the behavior of the valuation function. Unlike prior studies (such as Ohlson 1995 and Feltham and Ohlson 1995) where capital investments are either unspecified or exogenously given, capital investment decisions in this model are made contingent on the firm's operating profitability and growth opportunities. Valuation requires first forming beliefs about future capital investments, and then valuing cash flows to be generated from invested assets. Current earnings and book value provide vital information both for forming beliefs about future investments and for forecasting cash flows. With real options, the valuation function emerges as convex, not linear. Specifically, equity value is an increasing and convex function of earnings, for any given book value, but it can be either increasing in, insensitive to, or decreasing in book value, depending on the firm's profitability and growth opportunity. The model leads to predictions regarding the relative importance of earnings versus book value in value determination and how this relative importance varies across firms. It also rationalizes the quot;anomalousquot; association between stock prices and negative earnings found in empirical studies (which is due to regression model misspecification). The study further shows how conservative accounting affects the characteristics of earnings and book value, and provides hypotheses regarding how accounting conservatism influences the properties of the valuation function. The predictions of the model are generally consistent with the evidence reported in empirical studies. Implications for empirical research are discussed.
Author: Karin A. Petruska
Publisher:
ISBN:
Category : Accounting
Languages : en
Pages : 274
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Book Description
Accounting conservatism is often described as an equilibrium reaction used to moderate a decrease in value resulting from information asymmetry, uncertainty, or private information that occurs between investors and managers (LaFond and Watts, 2008). Although a qualitative characteristic of the FASB conceptual framework, standard setters have addressed concerns that accounting conservatism may lack neutrality and can lead to biased firm reporting that misrepresents economic conditions. Based on the theoretical framework of litigation proposed by Watts (2003), I address whether firms with higher thresholds of litigation risk are inclined to use higher levels of asymmetric timeliness as a choice in reducing information asymmetry. The motivation for this study is to extend the concept of accounting conservatism to a setting that investigates firms with egregious levels of litigation risk to determine if they exhibit higher levels of accounting conservatism. In terms of regulation, the Sarbanes-Oxley Act was enacted to increase transparency and disclosure in financial reporting and represents a more transparent shift in the information environment. I examine whether the asymmetric timeliness of earnings and firm-specific measures of accounting conservatism are more pronounced for alleged fraud firms in the post-SOX period, when litigation risk is expected to increase. In terms of standard setting, I examine if goodwill impairment is higher for firms accused of alleged fraudulent activity and whether these firms utilizing goodwill impairment maintain a higher degree of accounting conservatism. I investigate whether accounting conservatism, as a disclosure mechanism, can mitigate an increase in the cost of equity capital, even under the auspices of alleged fraud. Additionally, this study addresses the issue of whether there are contagion effects of asymmetric timeliness for firms in similar industries as the alleged fraud firms. The results suggest that the threat of litigation for alleged fraud firms invokes a higher degree of asymmetric timeliness surrounding the alleged fraud manipulation date in the financial statements vis-รก-vis a control sample and is driven by the accrual component of earnings. The degree of asymmetric timeliness of earnings remains higher in the post-SOX period for alleged fraud firms. However, the relation between firm-specific measures of accounting conservatism and the post-SOX period vary depending on the measure used. Goodwill impairment is higher for firms accused of alleged fraudulent activity and the asymmetric timeliness of earnings is greater for alleged fraud firms that utilize goodwill impairment. The relation between accounting conservatism and the cost of equity capital varies as to the measure used to construct the cost of equity capital. This suggests that firms are not able to influence the cost of equity capital through a more conservative disclosure policy. Also, there do not appear to be industry contagion effects. The findings lend support as to the role of accounting conservatism and why the FASB should continue to monitor its increasing effects. The results can provide support to investors, analysts, and academicians in adjusting for the effects of conservatism and to auditors in understanding how accounting conservatism could be used by firms and the multiple ways that it can be measured.
