Accounting and Valuation: How Helpful are Recent Accounting Rule Changes?

11 Pages Posted: 11 Dec 2006

See all articles by Bradford Cornell

Bradford Cornell

Anderson Graduate School of Management, UCLA

Wayne R. Landsman

University of North Carolina Kenan-Flagler Business School

Abstract

The longstanding debate over the proper definition of earnings - whether investors when setting stock prices focus primarily on GAAP earnings or other measures like operating cash flow - is both misguided and theoretically unresolvable. The biggest problem faced by investors in evaluating earnings reports is not their inability to understand the effects of the different accounting methods companies use when aggregating accounting line items into reported net income. More challenging, and more critical to the investment process, is getting complete and reliable information about the line items themselves. The authors' underlying premise is that investors, when provided sufficient information about these components of earnings, can combine or reconfigure them in whatever way they find most useful. But without sufficient and reliable information about the individual line items, investors will find it difficult to understand how earnings are generated and thus to produce the forecast of future earnings necessary to value a company.

In the past few years, there have been significant rule changes in accounting for employee options, derivatives, and special purposes entities. The authors evaluate the extent to which the new rules encourage disclosures that are helpful from a valuation perspective. Although there has been some progress, financial reporting in each of the three areas continues to fall well short of providing the complete, disaggregated data required to value a firm with confidence.

Suggested Citation

Cornell, Bradford and Landsman, Wayne R., Accounting and Valuation: How Helpful are Recent Accounting Rule Changes?. Journal of Applied Corporate Finance, Vol. 18, No. 4, pp. 44-52, Fall 2006, Available at SSRN: https://ssrn.com/abstract=950416 or http://dx.doi.org/10.1111/j.1745-6622.2006.00109.x

Bradford Cornell (Contact Author)

Anderson Graduate School of Management, UCLA ( email )

Pasadena, CA 91125
United States
626 833-9978 (Phone)

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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