Advertisement

Firm size proxies and the value relevance of predictive stock return models

  • Gulraze WakilEmail author
Article
  • 32 Downloads

Abstract

This paper investigates differences in value relevance of predictive stock return models depending on which firm size proxy (or proxies) is used, these being market value (MV), total book assets (TBA) and market value of total book assets (MVTA). Over the 27 year period of 1989–2015, MV provides higher value relevance in predicting future returns, while TBA provides higher value relevance when limited to large firms. Moreover, results reveal incremental explanatory power of approximately 27% when TBA are added to a one-year-ahead returns model already containing MV. The increase is 60% when examining only the last 10 years of the sample period. The findings of this study will help future accounting and finance research that uses predictive return models and potentially allow investors to make better resource allocation decisions leading to higher risk adjusted returns. In addition, the findings related to TBA will add to the debate on whether standard setters should place more emphasis on the valuation of assets and liabilities relative to earnings.

Keywords

Firm size Value relevance Accounting assets 

JEL classification

G12 G17 M410 

Notes

Acknowledgements

I thank Douglas Hannah, Merridee Bujaki, Sarah Dyce, Eric Johnson, Raj Mashruwala (discussant), Bruce McConomy, Steven Murphy, Karin Petruska, Robert Resutek (discussant) and Ralph Winter for their valuable suggestions. The paper has also benefited from comments received at the 2015 Telfer (U. of Ottawa) annual conference on accounting and finance, the 2014 Canadian Academic Accountants Association annual conference, the 2013 AAA annual conference and the 2013 AAA Mid-Atlantic region conference. Any errors or omissions are my own.

References

  1. Badertscher B, Hribar SP, Jenkins NT (2011) Informed trading and the market reaction to accounting restatements. Account Rev 86(5):1519–1547Google Scholar
  2. Balachandran S, Mohanram P (2011) Is the decline in the value relevance of accounting driven by increased conservatism? Rev Acc Stud 16(2):272–301Google Scholar
  3. Ball R, Brown P (1968) An empirical evaluation of accounting income numbers. J Account Res 6(2):159–178Google Scholar
  4. Ball R, Shivakumar L (2005) Earnings quality in U.K. private firms: comparative loss recognition timeliness. J Account Econ 39(1):83–128Google Scholar
  5. Banz RW (1981) The relation between return and market value of common stocks. J Financ Econ 9:3–18Google Scholar
  6. Bell TB, Landsman WR, Shackelford DA (2001) Auditors' perceived business risk and audit fees: analysis and evidence. J Account Res 39(1):35–43Google Scholar
  7. Berk J (1995) A critique of size related anomalies. Rev Financ Stud 8(2):275–286Google Scholar
  8. Berk J (1996) An empirical re-examination of the relation between firm size and return. University of Washington, Working PaperGoogle Scholar
  9. Berk J (1997) Does size really matter. Financ Anal J 53(5):12–18Google Scholar
  10. Bernard V (1995) The Feltham-Ohlson framework implications for empiricists. Contemp Account Res 11(2):733–747Google Scholar
  11. Biddle G, Seow S, Siegel A (1995) Relative versus incremental information content. Contemp Account Res 12(1):1–23Google Scholar
  12. Biddle G, Bowen R, Wallace JS (1997) Does EVA beat earnings? Evidence on associations with stock returns and firm values. J Account Econ 24:301–336Google Scholar
  13. Brown LD, Sivakumar K (2003) Comparing the value relevance of two operating income measures. Rev Acc Stud 8:561–572Google Scholar
  14. Bujaki ML, Richardson AJ (1997) A citation trail review of the uses of firm size in accounting research. J Account Lit 16:1–27Google Scholar
  15. Callen J, Khan M, Lu H (2013) Accounting quality, stock Price delay, and future stock returns. Contemp Account Res 30(1):269–295Google Scholar
  16. Campbell JY, Thompson SB (2008) Predicting excess stock returns out of sample: can anything beat the historical average? Rev Financ Stud 21(4):1509–1531Google Scholar
  17. Chava S, Purnanandam A (2010) Is default risk negatively related to stock returns? Rev Financ Stud 23(6):2523–2559Google Scholar
  18. Chen Y, Chang K (2010) Analyzing the nonlinear effects of firm size, profitability, and employee productivity on patent citations of the US pharmaceutical companies by using artificial neural network. Scientometr 82:75–82Google Scholar
  19. Cheng S (2004) R&D expenditures and CEO compensation. Account Rev 76(2):305–328Google Scholar
  20. Cheng Y, Peterson D, Sherrill K (2017) Admitting mistakes pays: the long term impact of goodwill impairment write-offs on stock prices. J Econ Financ 41:311–329Google Scholar
  21. Cochrane J (1999) New facts in finance. Econ Perspect 23:36–58Google Scholar
  22. Collins D, Gong G, Hribar P (2003) Investor sophistication and the mispricing of accruals. Rev Acc Stud 8(2–3):251–276Google Scholar
  23. Cooper MJ, Gulen H, Shchill MJ (2008) Asset growth and the cross-section of stock returns. J Financ 63(4):1609–1651Google Scholar
  24. Dechow P (1994) Accounting earnings and cash flows as measures of firm performance: The role of accounting accruals. J Account Econ 18:3–42Google Scholar
  25. Defond M, Raghunandan K, Subramanyam K (2002) Do non-audit service fees impair auditor independence? Evidence from going concern opinions. J Account Res 40(4):1247–1274Google Scholar
  26. Demerjian P (2011) Accounting standards and debt covenants: has the “balance sheet approach” led to a decline in the use of balance sheet covenants? J Account Econ 52:178–202Google Scholar
  27. Dichev I (2017) On the conceptual foundations of financial reporting. Account Bus Res 47(6):617–632Google Scholar
  28. Docherty P, Chan H, Easton S (2013) Australian evidence on the implementation of the size and value premia. Account Finance 53(2):367–391Google Scholar
  29. Easton P, Harris T, Ohlson JA (1992) Aggregate accounting earnings can explain most of security returns. J Account Econ 15:119–132Google Scholar
  30. Ecker F, Francis J, Kim I, Olsson P, Schipper K (2006) A returns-based representation of earnings quality. Account Rev 81(4):749–780Google Scholar
  31. Erkens DH, Bonner SE (2013) The role of firm status in appointments of accounting financial experts to audit committees. Account Rev 8(1):107–136Google Scholar
  32. Fama EF, French KR (1992) The cross-section of expected stock returns. J Financ 47(2):427–465Google Scholar
  33. Fama EG, French KR (1995) Size and book-to-market factors in earnings and returns. J Financ 50(1):131–155Google Scholar
  34. Fama EF, French KR (2002) Testing trade-off and pecking order predictions about dividends and debt. Rev Financ Stud 15(19):1–33Google Scholar
  35. Fama E, MacBeth JD (1973) Risk, return and equilibrium: empirical tests. J Polit Econ 81(3):607–636Google Scholar
  36. Financial Accounting Standards Board (2006) Preliminary views: conceptual framework for financial reporting. Financial Accounting Series 1260–001, Available at: http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1218220340119&acceptedDisclaimer=true. Accessed 1 Aug 2019
  37. Francis J, LaFond R, Olsson P, Schipper K (2005) The market pricing of accruals quality. J Account Econ 39:295–327Google Scholar
  38. Givoly D, Hayn C, Katz S (2017) The changing relevance of accounting information to debt holders over time. Rev Acc Stud 20(1):64–108Google Scholar
  39. Goh B, Krishnan J, Li D (2013) Auditor reporting under section 404: the association between the internal control and going concern audit opinions. Contemp Account Res 30(3):970–995Google Scholar
  40. Gompers P, Ishi J, Metrick A (2003) Corporate governance and equity prices. The Q J Econ February 118:107–155Google Scholar
  41. Griffin JM, Lemmon M (2002) Book-to-market equity, distress risk, and stock returns. J Financ 57(5):2317–2336Google Scholar
  42. Gujarati DN (2003) Basic econometrics, 4th edn. McGraw-Hill/Irwin, New York, NYGoogle Scholar
  43. IFRS Foundation (2010) The conceptual framework for financial reporting. A21-A52. Available at: https://www.ifrs.org/issued-standards/list-of-standards/conceptual-framework/. Accessed 1 Aug 2019
  44. Ince U, Owers JE (2012) The interaction of corporate dividend policy and capital structure decisions under differential tax regimes. J Econ Financ 36:33–57Google Scholar
  45. Jenkins DS, Kane GD, Velury U (2009) Earnings conservatism and value relevance across the business cycle. J Bus Financ Acc 36(9–10):1041–1058Google Scholar
  46. Jones D, Smith K (2011) Comparing the value relevance, predictive value, and persistence of other comprehensive income and special items. Account Rev 86(6):2047–2073Google Scholar
  47. Kang T, Lobo G, Wolfe M (2017) Accounting Conservatism and Firm Growth Financed by External Debt: The Role of Debt Maturity. J Account, Auditing and Financ 32(2):182-208Google Scholar
  48. Knez PJ, Ready MJ (1997) On the robustness of size and book-to-market in cross-sectional regressions. J Financ 52:1355–1382Google Scholar
  49. Lakonishok J, Shleifer A, Vishny RW (1994) Contrarian investment, extrapolation, and risk. J Financ 49(2):1541–1578Google Scholar
  50. Lam FY, Wei KC (2011) Limits-to-arbitrage, investment frictions, and the asset growth anomaly. J Financ Econ 102:127–149Google Scholar
  51. Lambert R, Leuz C, Verrecchia R (2007) Accounting information, disclosure, and the cost of capital. J Account Res 45(2):385–420Google Scholar
  52. Lara JMG, Osma BG, Penalvac F (2014) Information consequences of accounting conservatism. Eur Account Rev 23(2):173–198Google Scholar
  53. Moeller S, Schlingemannb FP, Stulz RM (2004) Firm size and the gains from acquisitions. J Financ Econ 73:201–228Google Scholar
  54. O'Brien PC, Bhushan R (1990) Analyst Following and Institutional Ownership, J Account Res 28(supplement):55–76Google Scholar
  55. Palmon D, Sudit E, Yezegel A (2008) The accruals anomaly and company size. Financ Anal J 64(5):47–60Google Scholar
  56. Pearce DK, Reiter SA (1985) Regression strategies when multicollinearity is a problem: a methodological note. J Account Res 23(1):405–407Google Scholar
  57. Penman S (2011) Accounting structure, specification, and inference in empirical accounting research. Working paper, Columbia University, referenced by permission. Available at: https://business.sydney.edu.au/__data/assets/pdf_file/0003/89562/Penman_MEAFA_2011.pdf. Accessed 1 Aug 2019
  58. Perez-Quiros G, Timmerman A (2000) Firm size and cyclical variations in stock returns. J Financ 55(3):1229–1262Google Scholar
  59. Powell J, Shi J, Smith T, Whaley R (2009) Common divisors, payout persistence, and return predictability. Int Rev Financ 9(4):335–357Google Scholar
  60. Rapach D, Zhou G (2013) Econ forecast 2A:330. North Holland, AmsterdamGoogle Scholar
  61. Sloan R (1996) Do stock prices fully reflect information in accruals and cash flows about future earnings? Account Rev 71(3):289–315Google Scholar
  62. Thomsen S, Pedersen T, Kvist HK (2006) Blockholder ownership: effects on firm value in market and control based governance systems. J Corp Finan 12:246–269Google Scholar
  63. van Dijk MA (2011) Is size dead? A review of the size effect in equity returns. J Bank Financ 35:3263–3274Google Scholar
  64. Vuong QH (1989) Likelihood ratio tests for model selection and non-nested hypotheses. Econom 57:307–333Google Scholar
  65. Watts RL, Zuo L (2016) Understanding practice and institutions: a historical perspective. Account Horiz 30(3):409–423Google Scholar
  66. Wooldridge JM (2010) Econometric analysis of cross section and panel data, 2nd edn. The MIT Press, Cambridge, MassachusettsGoogle Scholar

Copyright information

© Academy of Economics and Finance 2019

Authors and Affiliations

  1. 1.Ted Rogers School of Management, School of Accounting and FinanceRyerson UniversityTorontoCanada

Personalised recommendations