Does Fundamental Analysis Produce More Value-Relevant Summary Measures?

Abstract

In this study, I investigate how financial details (e.g., footnotes to the financial statements and 10-K supplementary schedules) disclosed concurrently with financial statements are priced by market participants. I test, not only the value-relevance of footnotes and supplementary data, but also the hypothesis that such disclosures are used by investors to restate bottom-line (GAAP-based) summary measures reported in a financial statement (e.g., total assets or total liabilities). The data of interest are disclosures that describe financial statement representations (e.g., explanatory information on inventory accounting practices), offer information that has not met GAAP-based recognition criteria (e.g., operating lease disclosures), or provide disaggregated information on financial statement representations.

I use the pedagogy in financial statement analysis textbooks and these disclosures to adjust GAAP-based indicators of firms' resources and obligations. I produce adjustments to financial statements for firms in five industries. The adjustments to firms' disclosures of resources and obligations are related to intangible capital, contingent liabilities, as well as net values of property plant & equipment, pension obligations, other post-employment benefit obligations, and operating leases. In the first step, I estimate a cross-sectional valuation model with multiple covariates (i.e., GAAP-based measures of assets and liabilities and the six adjustment variables) and find evidence that all six adjustments are priced by investors.

In the second step, I aggregate each adjustment to its related financial statement measure of total assets or total liabilities to produce adjusted measures of firms' resources and obligations. The goal is to find which of two competing models (i.e., reported versus adjusted summary measures) better represents the data generating process in the market values of common equity. I find that adjusted summary measures are significantly more associated with market values than reported GAAP-based summary measures.

JEL Classification: M41, M45, G12