The Term Structure of Capital Values: An Accounting-Based Framework for Measuring Economic Profitability

31 Pages Posted: 5 Sep 2015

See all articles by Carlo Alberto Magni

Carlo Alberto Magni

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering)

Ken V. Peasnell

Lancaster University - Department of Accounting and Finance

Date Written: September 5, 2015

Abstract

This paper shows how the outputs of the accounting measurement process can be translated into terms that can be used in economic decisions. We introduce the notion of Term Structure of Capital Values (TSCV), uniquely associated to a Term Structure of Interest Rates (TSIR). We show that the state of temporary disequilibrium created by an asset (project, firm, etc.) introduced in a market can be described in terms of a pair of internal TSCV and TSIR. Any internal TSCV determines a specific depreciation schedule for the asset and the corresponding TSIR determines an economic rate of return obtained as a capital-weighted average of the Return On Assets collected in the TSIR. The difference between this economic rate of return and the overall equilibrium rate (itself an average of the equilibrium forward rates) correctly captures value creation. The determination of a specific (internal) TSCV depends on the way the market sweeps away arbitrage opportunities and restores the equilibrium. As each possible accounting system can be viewed as being associated with a corresponding disequilibrium-to-equilibrium process and therefore with a corresponding economic rate of return, the paper shows that the determination of an economic rate of return is both a matter of accounting (in terms of a specific internal TSCV) and a matter of finance (in terms of a specific disequilibrium-to-equilibrium process). This evidently calls for a theory of capital valuation capable of associating the proper TSCV with each asset so that the intrinsic underdetermination of the economic rate of return can be solved.

Keywords: Average ROA, value creation, disequilibrium, term structure

JEL Classification: M41, G31, G11, G12

Suggested Citation

Magni, Carlo Alberto and Peasnell, Kenneth V., The Term Structure of Capital Values: An Accounting-Based Framework for Measuring Economic Profitability (September 5, 2015). Available at SSRN: https://ssrn.com/abstract=2656651 or http://dx.doi.org/10.2139/ssrn.2656651

Carlo Alberto Magni (Contact Author)

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering) ( email )

Italy

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)

Register to save articles to
your library

Register

Paper statistics

Downloads
68
Abstract Views
702
rank
330,273
PlumX Metrics