Using Accounting Information for Consumption Planning and Equity Valuation

Posted: 26 Feb 2007

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This article develops a consumption-based valuation model that treats earnings and cash flow as complementary information sources. The model integrates three ideas that do not appear in traditional valuation models: (i) earnings provide information about future shocks to cash flow; (ii) earnings contain indiscernible transient accruals; and (iii) investors use cash flow and earnings to make allocation and consumption decisions and set price. Accordingly, the quality of earnings affects production and consumption as well as price. Among other implications, the model reveals that a valuation coefficient is not just a capitalization factor; it is the product of a capitalization factor and a structural factor reflecting earnings quality and accounting bias.

Keywords: information quality, production, CAPM, cost of capital, DCF, resource allocation

JEL Classification: D51, E21, G12, G14, M21, M41

Suggested Citation

Yee, Kenton K., Using Accounting Information for Consumption Planning and Equity Valuation. Review of Accounting Studies, Vol. 12, No. 2-3, pp. 227-256, September 2007, Available at SSRN:

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