Investment Growth and the Relation Between Equity Value, Earnings, and Equity Book Value
Posted: 20 Mar 2011 Last revised: 8 Dec 2012
Date Written: March 17, 2011
Using Zhang (2000) as the theoretical basis, we predict and empirically test the effect of investment growth on the relation between equity value and accounting variables. We find that (i) growth increases the slope in the value-earnings relation for high-profitability firms (consistent with growth having positive NPV), but has an insignificant or negative effect on the slope for lower profitability firms (consistent with growth having non-positive NPV); (ii) given earnings, growth increases the (positive) slope of the relation between equity value and equity book value for low-profitability firms, but reduces this slope and causes equity value to decrease with book value for high-profitability firms; and (iii) given profitability (ROE), equity value uniformly increases with book value, and growth increases the slope of this relation. We also examine the valuation impact of past investment activities that arises from accounting conservatism. We find that the earnings coefficient is greater in the years following faster investment increases (which cause earnings to be more conservatively stated).
Keywords: investment growth, equity valuation, earnings, equity book value, profitability, conservatism
JEL Classification: M41, G12
Suggested Citation: Suggested Citation