Accounting Rules, Equity Valuation, and Growth Options

46 Pages Posted: 8 Dec 2015

See all articles by Dmitry Livdan

Dmitry Livdan

University of California, Berkeley

Alexander Nezlobin

London School of Economics & Political Science (LSE) - London School of Economics

Date Written: December 7, 2015

Abstract

In a model with irreversible capacity investments, we show that financial statements prepared under replacement cost accounting provide investors with sufficient information for equity valuation purposes. Under alternative accounting rules, including historical cost and value in use accounting, investors will generally not be able to value precisely a firm's growth options and, therefore, its equity. For these accounting rules, we describe the range of valuations that is consistent with the firm's financial statements. We further show that replacement cost accounting preserves all value-relevant information if the firm's investments are reversible. However, the directional relation between the value of the firm's equity and the replacement cost of its assets is different from that in the setting with irreversible investments.

Suggested Citation

Livdan, Dmitry and Nezlobin, Alexander, Accounting Rules, Equity Valuation, and Growth Options (December 7, 2015). Available at SSRN: https://ssrn.com/abstract=2700427 or http://dx.doi.org/10.2139/ssrn.2700427

Dmitry Livdan (Contact Author)

University of California, Berkeley ( email )

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Berkeley, CA 94720
United States
(510) 642-4733 (Phone)

Alexander Nezlobin

London School of Economics & Political Science (LSE) - London School of Economics ( email )

United Kingdom

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