... examine the relative roles o f earnings and non -earnings information in valuing R&D intensive firms In this model, the trade off between book value and expected future abnormal earnings makes the. .. other than the past history of earnings into their forecasts of future earnings If there were an increase in the importance o f other information to firm valuation then the coefficients in a regression... permission of the copyright owner Further reproduction prohibited without permission I i THE RELATIVE IMPORTANCE OF EARNINGS AND OTHER INFORMATION IN THE VALUATION OF R&D INTENSIVE FIRMS ! !
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Denise Jones MBA, University o f Colorado at Denver, 1996 MS Finance, University o f Colorado at Denver, 1996 B.S.B.A., Bryant College, 1989 A thesis submitted to the Faculty o f the Graduate School o f the University o f Colorado in partial fulfillment o f the requirement for the degree of Doctor o f Philosophy Department of Accounting 2000 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. UMI Number 9979354 _ ___ __ UMI UMI Microform9979354 Copyright 2000 by Bell & Howell Information and Learning Company. All rights reserved. This microform edition is protected against unauthorized copying under Title 17, United States Code. Bell & Howell Information and Learning Company 300 North Zeeb Road P.O. Box 1346 Ann Arbor, Ml 48106-1346 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. This thesis entitled: The Relative Importance of Earnings and Other Information in the Valuation of R&D Intensive Firms written by Denise Jones has been approved for the Department o f Accounting Lewis David ArGuenther Date ]y / 3/ ^ l o 1 1 ( * r - r b ,- i ) + + V \, + oaf_, = co^oa, + v 2r + e z,^ ( 2 a) ( 2 b) ( 2 c) 19 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. where: xt = operating earnings bt = book value r = discount factor oat = operating assets vu = other information about future abnormal earnings not contained in current abnormal earnings v2t = other information about future operating assets not contained in current operating assets Bn, S2t, 631 = unpredictable, mean zero disturbance terms co11 = persistence of abnormal earnings, 0 < con < 1 o 12 = correction for conservative accounting for operating assets, coi2 ^ 0 CO22 = growth in operating assets, 1 < o 22 < ( 1 + 0 7 = persistence o f other information, j y j < 1 The expectation of future abnormal earnings for firm i in period t can be expressed as a function of the current abnormal earnings expected to persist into the future, a correction for the conservatism in the accounting for operating assets, and alternative information about the future prospects o f the firm not contained in current abnormal earnings (such as long-term sales contracts, new product introductions, other growth opportunities, union negotiations, etc.). The expectation of future operating assets can be expressed as a function of current operating assets, which are expected to grow, and other information that would cause changes in future operating assets such as a restructuring or acquisition o f a new line o f business. The expectation of future other information can be expressed as the portion of the current other information that is expected to persist into the future. For example, if a new product is introduced then the future revenue from that product would increase future earnings. The other information is the increase to future earnings related to the new product. If the new product is a computer that is expected to generate revenue for four years then the other information related to the new computer would persist for four years into the future and this would be reflected in a 20 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. high y. If the other information is related to a strike that caused a temporary increase in salary expense then this information would not be expected to persist into the future and it would be reflected in a low y. Applying the stochastic process followed by abnormal earnings to the valuation model results in a linear information model (see Feltham and Ohlson 1995): MVt - bt + a, (x, - rbt_x) + a 2oat + a 2vt or, = tyn L! 1+ r - o ) u (3) a>r (l + r) a2= '- v ' (1 +r -eo ^ )(1 + r -[...]... value increases with the persistence of abnormal earnings and decreases with the persistence o f other information Given that the persistence of other information is the same or higher for R&D intensive firms and the persistence o f abnormal earnings is lower, then the coefficient on earnings of high R&D intensive firms will be lower This leads to hypothesis two (stated in alternative form): H2: The earnings. .. on the balance sheet Due to these offsetting influences, no prediction is made for this coefficient 3.2 I oluntary Disclosure o f Other Information As the importance o f other information in firm valuation increases, the probability of errors in firm valuation increases This is because other information is incorporated into firm valuation through its impact on the forecast o f future earnings Other information. .. hypothesis However, I do find that the coefficient on other information is significantly higher for R&D intensive firms For R&D intensive firms, the market places a higher weight on other information, presumably because the abnormal eamings are less persistent and alternative information sources are needed to value the firm Investigating the relative importance o f eamings and other information in firm... voluntarily, and the specific information provided varies by firm The first half of the dissertation establishes the importance o f other information, not contained in the basic financial statements, for the valuation o f R&D intensive firms The second research question I consider is whether the voluntary disclosure o f this other information mitigates difficulties in firm valuation Other information gets incorporated... changing technology Consistent with my hypothesis, I find that R&D intensive firms have less persistent abnormal earnings Whether the persistence of other information differs for R&D intensive firms is less clear High persistence of other information indicates that the impact o f the new information will persist for | several periods into the future Other information can take many different forms and. .. acquisition o f a new line o f business The expectation of future other information can be expressed as the portion of the current other information that is expected to persist into the future For example, if a new product is introduced then the future revenue from that product would increase future earnings The other information is the increase to future earnings related to the new product If the new product... determine if the magnitudes o f the coefficients on eamings and other information should differ for R&D intensive firms, I look at the theoretical values o f the coefficients The coefficients depend on the persistence o f abnormal eamings and the persistence o f other information I hypothesize that the persistence of abnormal earnings decreases with R&D intensity Many smaller R&D intensive firms are in. .. define other information as the difference between one-year ahead eamings forecasts and forecasts based on the time-series o f abnormal eamings As a first step in understanding differences in how abnormal eamings contribute to firm value for R&D intensive and non-R&D intensive firms, I address whether the magnitude of the valuation coefficients on eamings and other information differs for R&D intensive firms. .. for the ERC increase when analyst 18 Reproduced with permission of the copyright owner Further reproduction prohibited without permission forecasts are used is that analysts incorporate information other than the past history of earnings into their forecasts of future earnings If there were an increase in the importance o f other information to firm valuation then the coefficients in a regression of. .. intensive firms I The theoretical value o f the coefficient on eamings is positively related to the persistence o f abnormal earnings and inversely related to the persistence of other information Given the result that the persistence o f abnormal eamings is lower for j R&D intensive firms, I hypothesize that the eamings of R&D intensive firms are j valued less by the market than the eamings of firms with no