Do Investors Understand Really Dirty Surplus?

50 Pages Posted: 25 Jul 2010

See all articles by Wayne R. Landsman

Wayne R. Landsman

University of North Carolina Kenan-Flagler Business School

Bruce L. Miller

University of California, Los Angeles (UCLA) - Accounting Area

Ken V. Peasnell

Lancaster University - Department of Accounting and Finance

Shu Yeh

National Taiwan University - College of Management

Date Written: July 25, 2010

Abstract

This study addresses whether firms’ share prices correctly reflect two accounting measures, dirty surplus and really dirty surplus. Dirty surplus is readily observable from the financial statements, but really dirty surplus, which arises from recognizing equity transactions such as employee stock option exercises at other than fair market value, is not. Findings show that dirty surplus and really dirty surplus are irrelevant for forecasting abnormal comprehensive income. However, findings also indicate that investors appear to undervalue really dirty surplus. Hedge returns are insignificant when portfolios are formed based on dirty surplus, but are significantly positive based on really dirty surplus. Really dirty surplus positive hedge returns are robust to a variety of sensitivity tests. Taken together, the findings are consistent with either investors overvaluing firms that have large negative really dirty surplus or really dirty surplus being correlated with an unmodeled risk factor.

Keywords: Dirty Surplus Accounting, Equity Valuation, Hedge Returns

JEL Classification: M41

Suggested Citation

Landsman, Wayne R. and Miller, Bruce Leonard and Peasnell, Kenneth V. and Yeh, Shu, Do Investors Understand Really Dirty Surplus? (July 25, 2010). Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1648485 or http://dx.doi.org/10.2139/ssrn.1648485

Wayne R. Landsman (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-3221 (Phone)
919-962-4727 (Fax)

Bruce Leonard Miller

University of California, Los Angeles (UCLA) - Accounting Area ( email )

D410 Anderson Complex
Los Angeles, CA 90095-1481
United States
(310) 825-1814 (Phone)

Kenneth V. Peasnell

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom
+44 1524 593631 (Phone)
+44 1524 847321 (Fax)

Shu Yeh

National Taiwan University - College of Management ( email )

Department and Graduate Institute of Finance
College of Management
Taipei 106
Taiwan

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