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Review of Accounting Studies

, Volume 22, Issue 3, pp 1122–1155 | Cite as

Accounting rules, equity valuation, and growth options

  • Dmitry Livdan
  • Alexander NezlobinEmail author
Article

Abstract

In a model with irreversible capacity investments, we show that financial statements prepared under replacement cost accounting provide investors with sufficient information for equity valuation purposes. Under alternative accounting rules, including historical cost and value in use accounting, investors will generally not be able to value precisely a firm’s growth options and therefore its equity. For these accounting rules, we describe the range of valuations that is consistent with the firm’s financial statements. We further show that replacement cost accounting preserves all value-relevant information if the firm’s investments are reversible. However, the directional relation between the value of the firm’s equity and the replacement cost of its assets is different from that in the setting with irreversible investments.

Keywords

Equity valuation Real options Irreversible investment Accounting rules 

JEL Classification

E22 G31 M41 

Notes

Acknowledgements

We thank Tim Baldenius, Mary Barth, Jeremy Bertomeu, Davide Cianciaruso (discussant), Sunil Dutta, Jonathan Glover (discussant), Moritz Hiemann, Alastair Lawrence, Charles Lee, Guoyu Lin, Dmitry Makarov (discussant), Jim Ohlson, Stephen Penman, Tarun Ramadorai, Stefan Reichelstein (editor), Igor Vaysman, two anonymous reviewers, seminar participants at Columbia University, the University of Vienna, and the participants of the 4th International Moscow Finance Conference, the 12th Workshop on Accounting and Economics in Tilburg, 2015 Berkeley-Stanford Joint Workshop, and 2016 Review of Accounting Studies conference for their helpful comments and suggestions.

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Copyright information

© Springer Science+Business Media New York 2017

Authors and Affiliations

  1. 1.Haas School of BusinessUniversity of CaliforniaBerkeleyUSA

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