The Effects of Scale Differences on Inferences in Accounting Research: Coefficient Estimates, Tests of Incremental Association, and Relative Value Relevance

MIT Sloan Working Paper No. 4490-04

Sauder School of Business Working Paper

49 Pages Posted: 8 Jun 2004

See all articles by Kin Lo

Kin Lo

University of British Columbia (UBC) - Sauder School of Business

Date Written: March 14, 2004

Abstract

Firms' financial data vary considerably with the size of their operations. Such scale differences potentially confound several types of inferences, of which this paper analyzes three. This paper evaluates two potential solutions to these inference problems suggested by theory: (i) deflating the data by a proxy for scale; and (ii) including a scale proxy as an independent variable. First, simulations of bivariate and multivariate regressions show that deflating the data mitigates coefficient bias as effectively as including that proxy as an independent variable. Reconciling this result with the conclusions of Barth and Kallapur (1996, Contemporary Accounting Research) reveals that the prior study (unknowingly) made assumptions that are both economically and statistically unreasonable. Second, deflation results in more accurate tests in terms of mean squared error. Third, deflating by a scale proxy results in well-specified tests of relative association using Vuong's (1989) Z-statistic for non-nested models whereas including the scale proxy as an independent variable results in overstated significance. These results suggest that deflating scale-affected variables is at least as good, and under some statistical criteria, superior to an alternative that uses a scale proxy as a regressor.

Keywords: Econometric models, Capital markets, Financial reporting, Equity valuation

JEL Classification: C51, G10, M41, M44

Suggested Citation

Lo, Kin, The Effects of Scale Differences on Inferences in Accounting Research: Coefficient Estimates, Tests of Incremental Association, and Relative Value Relevance (March 14, 2004). MIT Sloan Working Paper No. 4490-04; Sauder School of Business Working Paper. Available at SSRN: https://ssrn.com/abstract=555684 or http://dx.doi.org/10.2139/ssrn.555684

Kin Lo (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8430 (Phone)
604-822-9470 (Fax)

HOME PAGE: http://www.sauder.ubc.ca/Faculty/People/Faculty_Members/Lo_Kin

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
607
Abstract Views
3,372
rank
45,737
PlumX Metrics