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Abstract:
Standard equity valuation approaches (i.e., DDM, RIM, and DCF) are derived under the assumption of ideal conditions, such as infinite payoffs and clean surplus accounting. Since these conditions are hardly ever met, we provide extensions of the standard approaches based on the fundamental principle of integrated financial planning. Empirically, our extended models yield considerably smaller valuation errors. Moreover, by construction, identical value estimates are obtained across the extended models. Re-establishing empirical equivalence under non-ideal conditions, our approach provides a benchmark that allows us to quantify the errors resulting from individual deviations from ideal conditions, and thus, to analyze the robustness of the standard approaches.

Dividend Discount Model, Residual Income, Discounted Cash Flow, Dirty Surplus, Terminal Value, Valuation Error

Abstract:
Recent research concerned with enhancing conservatism corrections of linear information models (LIMs) reports a decrease in bias as compared to the Ohlson (1995) model. However, inaccuracy is not significantly reduced. These findings raise two questions: First, are LIMs able to capture unconditional conservatism? Second, if conservatism can be captured, then why is accuracy not markedly improved? With regard to the first question, we find that conservatism is captured when the Feltham/Ohlson (1995) model is estimated according to the modification suggested by Choi/O'Hanlon/Pope (2006). On average, one dollar of unrecorded reserves, measured as the estimated reserve by Penman/Zhang (2002), results in a correction of market value forecasts of approximately one dollar. Furthermore, our results suggest no improvement of the conservatism corrections for the following cases: (1) disaggregating book value into operating and financial assets and (2) estimating the Feltham/Ohlson (1995) model via the valuation function. Regarding the second question, we argue that the failure of the models to markedly reduce inaccuracy is the consequence of forcing the models to value different firms on the basis of the same conservatism coefficient. We therefore suggest an estimation procedure, in which LIM parameters are estimated separately for different conservatism levels. Our implementation reduces median inaccuracy from 36.8% to 21.1%, which is comparable to implementations of the residual income model based on analyst forecasts.

Accounting Conservatism, Residual Income Valuation, Feltham-Ohlson Model, Linear Information Model, Equity Valuation

Abstract:
This study addresses the problem of differences between firms and the impact on valuations based on multiples. We investigate the extent to which industry-based multiples ignore additional firm-specific information and develop measures for identifying peer groups that are not comparable with the target firm. Additionally, we compare the performance of different methods that control for differences between firms. We find that differences between firms lead to systematic errors in the value estimates of different multiples. These errors are consistent with our hypotheses, statistically significant, economically substantial, consistent between different value drivers and robust over time. We find that these errors can be predicted very accurately by comparing the financial ratios of the target firm with the financial ratios of its peer group. We show that when adequately controlling for differences between firms, valuation accuracy is improved substantially and all considered value drivers perform almost equally well.

equity valuation, multiple valuation method, price-earnings, comparables, ratio analyses, financial ratios

Abstract:
We interpret cost stickiness, i.e., the manager's decision to bear the costs of unutilized resources when sales decline, as a risky project and examine its impact on conditional conservatism. We find that cost stickiness increases the asymmetric timeliness of earnings by weakening the timeliness of earnings for good news firms and, at the same time, intensifying the timeliness of earnings for bad news firms. Additionally, the results suggest that the asymmetric timeliness of earnings for cost sticky firms is more strongly driven through accounting factors, as reflected in accruals than through non-accounting factors, as reflected in cash flow. Our results imply that cost stickiness is more costly due to conditional conservatism and that the market separates the efficient from the inefficient cost sticky firms indicating that information asymmetry is low. Future research could test whether conditional conservatism helps mitigating the information asymmetry induced by cost stickiness.

Accounting Conservatism, Asymmetric Timeliness of Earnings, Basu (1997), Conditional Conservatism, Cost Stickiness

Abstract:
We examine the impact of global IFRS adoption on cross-border equity investments by individual investors. The Open Market at Frankfurt Stock Exchange, a segment designed for German individual investors to trade a large selection of foreign stocks, provides an ideal setting to address this research question. Using a sample of 4,869 firms from 31 countries around the world, we find that stocks experience an increase in Open Market trading activity following mandatory adoption of IFRS. This increase is both economically and statistically significant. Our results are consistent with the idea that collective IFRS adoption has the potential to reinforce foreign equity investments not only by professional institutional investors (e.g. Covrig et al. (2007), Florou and Pope (2009)), but also by individual investors.

individual investors, international accounting, IFRS, open market, trading activity, foreign equity investments

Abstract:
We provide evidence that conditional conservatism could be better captured in linear information models (LIMs), which largely rely on analysts' forecasts, if analysts would adjust their optimistic forecast for the asymmetric timeliness of earnings. Since adjusting the forecast requires information of the next period the adjusted model could be regarded as a benchmark to investigate conditional conservatism in LIMs. We demonstrate that for a joint parameter estimation of the Choi/O'Hanlon/Pope (2006) model based on adjusted forecasts valuation errors are reduced. For a market-to-book specific implementation the adjusted model improves valuation errors for the 30% highest conservative firms. Moreover, the adjustment reduces the asymmetric timeliness in the valuation error indicating that the adjusted model helps capturing conditional conservatism. Our results imply that LIMs will benefit from an adjustment for conditional conservatism particularly in the case of a joint parameter estimation and when concern is with high conservative firms.

Linear Information Model, Ohlson Model, Accounting Conservatism, Asymmetric Timeliness of Earnings, Basu (1997), Conditional Conservatism

Abstract:
This study provides evidence on the determinants of contract terms between professional services firms and their clients. Because professional services are typically characterized by a high degree of transactional uncertainty and a double moral hazard risk, contracts can be essential for the creation of incentives to control the behavior of those involved in the service encounter. Based on both agency and organizational theory, hypotheses on the determinants of implementing a specific type of cost contract are developed and tested empirically with respect to management consulting firms. Our results indicate that (1) service characteristics exert a significant impact on the chosen contract type, (2) performance-based contracts may not be optimal, even if service output is measurable and verifiable, and (3) experience-based trust and reputation impact on the choice of controls used in short-term contracts. These results contribute to the field of management accounting by providing insights into the design of management control systems in service organizations.

cost contracts, customer integration, double moral hazard, incentives, professional services

Abstract:
In implementing an ABC-system, the selection of cost drivers is a major issue since accuracy must be traded off against the complexity of the ABC-system. On one hand, a high accuracy in allocating overhead costs often requires a high number of cost drivers. On the other hand, a small number of cost drivers is desirable to achieve acceptable information-cost and to make the ABC-system easier for management to understand. In this paper a mathematical model to support optimal cost driver selection is developed. While existing approaches consider only the possible replacement of one cost driver by just one other cost driver, the model takes into account that cost drivers can also be replaced by combinations of cost drivers. This approach yields a more accurate cost allocation with the same ABC-system complexity.

Activity-based costing; Cost driver accuracy; Cost driver selection; Cost driver combinations