Accruals, Accounting-Based Valuation Models, and the Prediction of Equity Values

60 Pages Posted: 29 May 2004

See all articles by Mary E. Barth

Mary E. Barth

Stanford University - Graduate School of Business

William H. Beaver

Stanford University

John R. M. Hand

University of North Carolina Kenan-Flagler Business School

Wayne R. Landsman

University of North Carolina Kenan-Flagler Business School

Date Written: May 26, 2004

Abstract

This study uses out-of-sample equity value estimates to determine whether earnings disaggregation, imposing valuation model linear information (LIM) structure, and separate industry estimation of valuation model parameters aid in predicting contemporaneous equity values. We consider three levels of earnings disaggregation: aggregate earnings, cash flow and total accruals, and cash flow and four major components of accruals. For pooled estimations, imposing the LIM structure results in significantly smaller prediction errors; for by-industry estimations, it does not. However, by-industry prediction errors are substantially smaller, suggesting the by-industry estimations are better specified. Mean prediction errors are smallest when disaggregating earnings into cash flow and major accrual components; median prediction errors are smallest when disaggregating earnings into cash flow and total accruals. These findings suggest that (1) If concern is with errors in the tails of the equity value prediction error distribution, then earnings should be disaggregated into cash flow and the major accrual components; otherwise earnings should be disaggregated only into cash flow and total accruals. (2) Imposing the LIM structure is not costly; (3) Valuation of abnormal earnings, accruals, accrual components, equity book value, and other information varies significantly across industries.

Keywords: Accruals, Valuation, Out-of-sample prediction

JEL Classification: G12, M41

Suggested Citation

Barth, Mary E. and Beaver, William H. and Hand, John R. M. and Landsman, Wayne R., Accruals, Accounting-Based Valuation Models, and the Prediction of Equity Values (May 26, 2004). Available at SSRN: https://ssrn.com/abstract=551683 or http://dx.doi.org/10.2139/ssrn.551683

Mary E. Barth

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-9040 (Phone)
650-725-0468 (Fax)

William H. Beaver (Contact Author)

Stanford University ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-4409 (Phone)
650-725-6152 (Fax)

John R. M. Hand

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-3173 (Phone)
919-962-4727 (Fax)

Wayne R. Landsman

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-3221 (Phone)
919-962-4727 (Fax)

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