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Accounting Measurement and Capital Markets Research
Abstract
Numerous controversies — from goodwill amortisation to the appropriateness of fair value accounting — illustrate both the importance of measurement questions, and the difficulty often encountered in devising accounting measurement “solutions” that are widely accepted. This paper discusses what might be learned about accounting measurement questions from the perspective of capital markets-based research. While this field of inquiry is not well developed, there are indications that further research from the capital markets perspective could provide useful conclusions about accounting measurement.
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We investigate the value‐relevance of capitalised R&D on the balance sheet, and the extent to which R&D accruals improve the association between accounting‐based measures of firm perfor Mance and capital market returns for Australian listed companies. This is a regulatory setting where management discretion in the capitalisation decision is permitted and can be empirically observed. Our results suggest that capitalised R&D on the balance sheets of selective capitalisers is value‐relevant; that is, the ability of capitalised R&D to explain infor Mation contained in prices (given infor Mation conveyed by other components of the balance sheet) is statistically significant. For the same group of firms R&D accruals (particularly the initial capitalisation) improve accounting earnings as a measure of perfor Mance but only for the pooled sample using contemporaneous returns. The results for the fully expensing sample are less clear, perhaps due to the small sample size.
We synthesize and extend research exploring differences between U.S. and other countries' Generally Accepted Accounting Principles (GAAP) by investigating whether differences between domestic and U.S. GAAP for U.S.-listėd U.K., Australian, and Canadian firms are associated with firms' returns and prices. The accounting differences we investigate include goodwill, asset revaluations, income taxes, pensions, interest capitalization, foreign currency, and extractive industries accounting. We conclude that goodwill is priced as an asset; that asset revaluations, successful efforts accounting for extractive industries, and immediate recognition of foreign currency exchange gains and losses on long-term assets and liabilities are generally uncorrelated with the information that investors consider relevant; that U.K., U.S., and Australian tax accounting methods do not recognize 'enough' tax expense or liability; and that accrual pension accounting and, in some specifications, interest capitalization add explanatory power beyond Australia's cash-based method. Our findings suggest that the U.S. Securities and Exchange Commission's (SEC's) required GAAP reconciliation reflects information useful to investors for U.K. and Australian firms, and to a more limited extent, for Canadian firms.
The results of tests reported in this paper show that asset revaluations accounted for in accordance with AAS 10/AASB 1010 provide information that is consistent with the information set used by investors in pricing the shares of a sample of Australian listed firms. The “value relevance” of asset revaluations occurs in periods of both rising and declining asset prices.
Accounting academics and practitioners have been known to question whether accounting research is as efficacious as it might be. This paper focuses on capital markets-based research in accounting and how its potential contribution to the wider regulatory process can be realised more fully. Examples used are: research on corporate regulation; the move to ‘harmonise’ accounting standards; accounting for R&D; accounting for goodwill; and equity accounting.
We show harmonizing domestic GAAP with foreign GAAP can have deleterious effects on security market performance, specifically price informativeness and trading volume. Harmonization effects result from interaction between two forces. Direct informational effects depend on whether harmonization increases or decreases GAAP precision. Expertise acquisition effects depend on benefits and costs to foreign investors of becoming domestic GAAP experts. These countervailing forces can result in harmonization to more (less) precise GAAP increasing (decreasing) or, unexpectedly, decreasing (increasing) price informativeness and trading volume. We also observe this for a cost of capital metric. Thus, harmonization is not necessarily a desirable singular goal.
This study investigates how Australian asset revaluations are associated with share prices and non market-based firm value estimates. We find that revalued financial, tangible, and intangible assets can be value-relevant. Although prior research presages the financial assets findings, the intangible assets findings are striking in strength and consistency. Findings for property, plant, and equipment are less consistent. Also, we find stronger value-relevance for plant and equipment than for property, suggesting revalued operating assets are more value-relevant. Perhaps surprisingly, the market does not distinguish director- and independent appraiser-based valuations, consistent with directors' enhancing value estimates by using their private information countervailing distorting effects associated with management discretion. Also, even several year old revalued amounts are value-relevant, suggesting timeliness is not critical for long-term asset revaluations. Finally, evidence indicates that investors value differently upward and downward revaluations, suggesting the discretionary nature of asset write-ups can affect value-relevance.
This paper discusses the relation between financial reporting research and practice, particularly standard setters. Many studies addressing financial reporting issues use a valuation approach. The paper describes alternative approaches to valuation research and summarises the findings relating to four major current issues: fair value accounting for financial, tangible, and intangible assets, cash flows versus accruals, recognition versus disclosure, and international harmonisation of accounting standards. The summaries include identifying what standard setters and others would like to learn from research, what we have learned, and what is left to learn. The paper concludes with observations about future financial reporting academic research.
Australian GAAP requires firms to either disclose or recognize the current values of property in their financial statements. We investigate why managers of some firms choose to recognize revaluation increments in their financial statements while others choose simply to disclose. We propose that the propensity to recognize is related to the degree of management certainty that the value increase will be realized in future cash flows. In support of this proposition, we find that firms recognizing a revaluation increment (a) tend to have assets that are more general than specific, and (b) are more likely to have subsequent increases in operating performance. Our results indicate that, for asset revaluations at least, disclosure and recognition are different in terms of the signal that they convey about the underlying reliability of the measure.
The paper develops and analyzes a model of a firm's market value as it relates to contemporaneous and future earnings, book values, and dividends. Two owners' equity accounting constructs provide the underpinnings of the model: the clean surplus relation applies, and dividends reduce current book value but do not affect current earnings. The model satisfies many appealing properties, and it provides a useful benchmark when one conceptualizes how market value relates to accounting data and other information.
Résumé. L'auteur élabore et analyse un modèle dans lequel il conceptualise la relation entre la valeur marchande d'une entreprise et ses bénéfices, ses valeurs comptables et ses dividendes actuels et futurs. Deux postulats de la comptabilisation des capitaux propres servent de charpente au modèle: a) la relation du résultat global s'applique et b) les dividendes réduisent la valeur comptable actuelle sans influer, cependant, sur les bénéfices actuels. Le modèle présente de nombreuses propriétés intéressantes et il peut, fort utilement, servir de repère dans la conceptualisation de la relation entre la valeur marchande et les données comptables et autres renseignements.
This paper models the relation between a firm's market value and accounting data concerning operating and financial activities. Book value equals market value for financial activities, but they can differ for operating activities. Market value is assumed to equal the net present value of expected future dividends, and is shown, under clean surplus accounting , to also equal book value plus the net present value of expected future abnormal earnings (which equals accounting earnings minus an interest charge on opening book value).
A linear model specifies the dynamics of an information set that includes book value and abnormal earnings for operating activities. Model parameters represent persistence of abnormal earnings, growth , and accounting conservatism. The model is sufficiently simple to permit derivation of closed form expressions relating market value to accounting data and other information.
Three kinds of analyses develop from the model. The first set deals with value as it relates to anticipated realizations of accounting data. The second set examines in precise terms how value depends on contemporaneous realizations of accounting data. The third set examines asymptotic relations comparing market value to earnings and book values, and how earnings relate to beginning of period book values.
The paper demonstrates that in all three sets of analyses the conclusions hinge on the extent to which the accounting is conservative as opposed to unbiased. Further, the absence/presence of growth in operating activities is relevant if, and only if, the accounting is conservative.
Résumé. Les auteurs présentent sous forme de modèle la relation entre la valeur marchande d'une entreprise et les données comptables relatives à ses activités d'exploitation et ses activités financières. La valeur comptable est égale à la valeur marchande lorsqu'il s'agit d'activités financières, mais elle peut être différente dans le cas des activités d'exploitation. Les auteurs supposent que la valeur marchande est égale à la valeur actualisée nette des dividendes futurs prévus et démontrent que, lorsqu'on applique la méthode du résultat global , la valeur marchande est aussi égale à la valeur comptable additionnée de la valeur actualisée nette des bénéfices extraordinaires futurs prévus (qui sont égaux aux bénéfices comptables diminués de frais d'intérêt implicites sur la valeur comptable nette).
Un modèle linéaire précise la dynamique d'un ensemble de données, incluant la valeur comptable et les bénéfices extraordinaires, relatives aux activités d'exploitation. Les paramètres du modèle traduisent la persistance des bénéfices extraordinaires, la croissance et le principe de prudence. Le modèle est suffisamment simple pour permettre de dériver des expressions fermées qui mettent en relation la valeur marchande et les données comptables et autres.
Du modèle se dégagent trois formes d'analyses. La première porte sur la valeur, dans sa relation avec la matérialisation anticipée des données comptables. La deuxième porte sur l'examen précis du lien entre la valeur et la matérialisation actuelle des données comptables. Enfin, la troisième porte sur l'examen des relations asymptotiques à travers lesquelles se comparent la valeur marchande, d'une part, et les bénéfices et la valeur comptable, d'autre part, ainsi que sur la façon dont les bénéfices se rattachent aux valeurs comptables du début de l'exercice.
Les auteurs établissent que dans les trois formes d'analyses, les conclusions s'orientent vers la mesure dans laquelle, dans le domaine comptable, l'accent est mis sur la prudence par opposition à l'impartialité. En outre, l'absence ou la présence de croissance dans les activités d'exploitation n'est pertinente que si et seulement si le principe de prudence est appliqué à la comptabilité.
I review empirical research on the relation between capital markets and financial statements. The principal sources of demand for capital markets research in accounting are fundamental analysis and valuation, tests of market efficiency, and the role of accounting numbers in contracts and the political process. The capital markets research topics of current interest to researchers include tests of market efficiency with respect to accounting information, fundamental analysis, and value relevance of financial reporting. Evidence from research on these topics is likely to be helpful in capital market investment decisions, accounting standard setting, and corporate financial disclosure decisions.
We find, as predicted, that upward revaluations of fixed assets by UK firms are significantly positively related to changes in future performance, measured by operating income and cash from operations, indicating revaluations reflect asset value changes. Current year revaluations (revaluation balances) also are significantly positively related to annual returns (prices). Relations between revaluations and future performance and prices are weaker for higher debt-to-equity ratio firms, indicating motivation affects how revaluations reflect asset value changes. The relations also are weaker for cross-listed firms and in a more volatile economic time period. Our inferences are robust to controlling for firms' acquisition activity.
Our recognition and disclosure model reveals that price informativeness is determined by the interaction of the qualities of three information sources-the recognized amount, the disclosed information, and the information revealed by price-and accounting expertise acquisition. It also reveals that recognition of an accounting amount alters each of these, thereby affecting price informativeness. Perhaps surprisingly, we find that recognition of a highly unreliable accounting amount, rather than simply disclosing it, can result in greater price informativeness. Likewise, recognition of a highly reliable amount can result in lower price informativeness. Our findings suggest that, because of the effects of aggregation, basing recognition decisions on reliability alone is too simplistic. Reliability relative to relevance is key, not reliability per se. We also find that recognition and disclosure affect the coefficients in a regression of price on accounting amounts. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2003.
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