Accounting Conservatism and the Valuation of Accounting Numbers: Evidence on the Feltham-Ohlson (1996) Model
22 Pages Posted: 6 Nov 1998
This study documents evidence on the valuation effects of accounting conservatism in the context of the Feltham-Ohlson  model. We find, consistent with the model's predictions, that goodwill (the difference between market and book value of equity) is a function of abnormal operating earnings and beginning operating assets. Our test results support two further implications of the FO model: (1) the effect of abnormal operating earnings on goodwill increases with operating cash receipts persistence, and (2) the effect of operating assets on goodwill increases with the difference between cash receipts persistence and the depreciation parameter. Generally, the estimated coefficients from the FO model correspond to their implied theoretical values. However, we reject a paired-sample test of equality of medians between the estimated beginning operating asset weights and those implied by our persistence, depreciation, and cost of capital parameters. We interpret our results as supporting the qualitative features and the underlying intuition of the model.
JEL Classification: M4
Suggested Citation: Suggested Citation