Author: Ho, Sandra Wai-man
Title: Two essays on the role of accounting information in firm valuation : empirical evidence from Japan
Degree: Ph.D.
Year: 2000
Subject: Corporations -- Valuation -- Japan
Accounting -- Japan
Hong Kong Polytechnic University -- Dissertations
Department: Department of Accountancy
Pages: ix, 178 leaves ; 30 cm
Language: English
Abstract: This thesis consists of two essays and provides empirical evidence on the role of accounting information in firm valuation, using a sample of Japanese listed firms. The first essay, framed within the context of Feltham and Ohlson (FO: 1995), examines the extent to which stock price is explained by three accounting fundamentals, namely book value of equity, (abnormal) operating earnings, and operating assets. In addition, it assesses how earnings persistence, accounting conservatism, growth, and their combinations differentially affect the role of accounting measures in firm valuation. Results confirm that book value of equity and abnormal operating earnings are positively associated with prices. However, contrary to the prediction of FO (1995), operating assets have a negative instead of positive impact on firm valuation, which implies aggressive accounting. This is contrary to common accounting practices, especially given that Japanese accounting is more conservative than US accounting (Cheung, Kim, and Lee; 2000). The negative result may also be interpreted as investors not perceiving operating assets rationally. Alternatively, multicollinearity of book value and operating assets may drive the coefficient of operating assets negative. Converting the price model into a goodwill model reveals the positive valuation impact of operating assets. In addition, evidence shows that the market places higher value on firms maintaining higher earnings persistence or adopting more conservative accounting practices but not on firms undergoing higher growth. Evidence also supports that, other things being equal, earnings persistence, but not growth, accentuates the valuation effect of accounting conservatism. The negative results associated with growth may be contributed by the inconsistent results obtained for the linear information model (LIM). Alternatively, the results may be explained by growing firms having higher proportion of undepreciated new assets, thus mitigating the effect of conservatism on book values (Beaver and Ryan, 2000). On the other hand, the negative results may fit into the scenario of firms having negative growth. While the Japanese stock market boomed in the 1980's, it experienced a sharp downturn from 1990 onwards. Inferred from Beaver and Ryan (2000), negative growth results in higher unrecorded goodwill. Furthermore, inferred from Ryan (1995) and Beaver and Ryan (2000), an alternative measure of accounting conservatism based on the proportion of depreciable fixed assets gives results supporting the positive valuation effect of accounting conservatism. However, accounting conservatism inferred from the remaining useful lives of depreciable assets decreases rather than increases goodwill. This may be interpreted as investors viewing companies having assets with short remaining lives as more conservative since these firms depreciate asset costs faster. Moreover, firms with assets of long remaining lives have relatively higher proportions of new assets on hand which have book values equal to market values (Ryan, 1995), therefore their book values are relatively less understated. Results are sensitive to macroeconomic and industry variables added to proxy for the other non-accounting information in the FO (1995) valuation model. For instance, the year and industry dummies increase the adjusted R-squares of the valuation models by 4% to 29%, indicating that such non-accounting information has incremental explanatory power beyond abnormal operating earnings and operating assets in explaining the variation in unrecorded goodwill. Their inclusion also accentuates the valuation impact of operating assets but decreases the valuation impact of accounting conservatism. Moreover, the valuation effect of operating assets no longer increases with conservatism. Other than these changes, they do not significantly reverse the general trend of the results. These negative results may be attributed to the failure of the linear information dynamics to precisely capture the effects of accounting conservatism and growth of operating assets. Consistent with the findings of Myers (1999) and Stober (1996), high proportions of the empirical estimates of the conservatism and growth parameters in the LIM fall outside their restricted bounds, which are part of the crucial assumptions of the FO linear valuation model. The second essay of this thesis examines the valuation effects of positive vs. negative earnings, book value and discretionary accruals, using a sample of Japanese listed firms over the period of 1975-1995. Consistent with US evidence such as Hayn (1995), Jan and Ou (1995) and Collins et al. (1999), omission of book value from the simple earnings capitalization model causes Japanese stock prices to be negatively, though insignificantly, associated with losses but significantly positively associated with profits. The negative price-earnings association is weaker for Japanese loss firms while the positive price-earnings association is much stronger for profit firms compared with US evidence. This is consistent with extant literature documenting the pervasive use of more conservative accounting practices by Japanese firms than by US firms, and the stock bubble of the Japanese market. The negative price-earnings association for loss firms is reversed when book value of equity is added as an omitted correlated explanatory variable. Book value is value-relevant and has incremental explanatory power beyond earnings. Moreover, its omission causes a positive bias of the coefficient on positive earnings. Results also reveal that investors value earnings (book value) more than book value (earnings) for profit (loss) firms. This is because investors view losses as transitory whereas book value reflects the abandonment value of loss firms, consistent with Collins et al. (1999) and Burgstahler and Dichev (1997), among others. Lastly, evidence suggests that the Japanese market prices discretionary accruals, which enhance the value relevance of reported earnings. They signal managers' private information on firm profitability and help smooth income in a way desirable by investors. Results are robust to various sensitivity checks including foreign investors' holdings, firm size, the level of debt financing and strength of Keiretsu ties. Overall, discretionary accruals are more significantly priced in Japan than in the US, this is consistent with the unique corporate governance of Japan. The joint ownership of debt and equity by financial institutions, interlocking ownership, significant inter-group (Keiretsu) holdings, together with group management dynamics result in far closer ties and less information asymmetry between Japanese investors and management (Ho et al., 2000; Jacobson and Aaker 1993; Kagono et al., 1983). Hence there is less incentive for managerial opportunism in Japan than in the US, rendering discretionary accruals relatively more informative and significantly priced by the Japanese market.
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Access: restricted access

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