Alternative Adaptations of Distressed Firms' Resources: The Valuation Roles of Book Value of Equity and Earnings

40 Pages Posted: 11 Apr 2004

See all articles by Christine E.L. Tan

Christine E.L. Tan

City University of New York - Baruch College

Date Written: March 2004

Abstract

I examine the relative valuation importance of book value of equity and net income of financially distressed firms that subsequently resolve their problem of financial difficulties through a merger or entering bankruptcy. Recent studies examine the complimentary roles of book value of equity and earnings in valuing equity. Book value of equity is more value-relevant for financially distressed (bankrupt) firms and earnings are more value-relevant for healthy (non-bankrupt) firms. However, these findings are consistent with two competing theories. I distinguish between these two theories and show that only book value of equity is significantly associated with market value for distressed firms that are bankruptcy candidates. For distressed firms that are merger candidates, I show that both book value of equity and net income are significantly associated with market value. The empirical evidence also provides a direct link between the alternative valuation roles of book value of equity and market value of equity. The results are robust after controlling for non-recurring items, industry, firm size and agency conflicts.

Keywords: Adaptation option; Liquidation option; Value relevance; Financial distress; Merger; Bankruptcy

JEL Classification: G12, G33, M41

Suggested Citation

Tan, Christine, Alternative Adaptations of Distressed Firms' Resources: The Valuation Roles of Book Value of Equity and Earnings (March 2004). Available at SSRN: https://ssrn.com/abstract=293125 or http://dx.doi.org/10.2139/ssrn.293125

Christine Tan (Contact Author)

City University of New York - Baruch College ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
646-312-3206 (Phone)
646-312-3161 (Fax)

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