Doina C. Chichernea, Anthony D. Holder and Jie (Diana) Wei
The purpose of this paper is to investigate the connection between the accrual quality and the growth/value characteristics (and their return premia) at firm level.
Abstract
Purpose
The purpose of this paper is to investigate the connection between the accrual quality and the growth/value characteristics (and their return premia) at firm level.
Design/methodology/approach
The paper employs a battery of univariate and multivariate cross‐sectional tests. Fama‐MacBeth regressions with main effects and interaction effects are used to identify the relation between accrual quality, book‐to‐market and returns. The analysis is conducted on the overall sample, as well as after conditioning on up and down markets.
Findings
Value (growth) stocks are more likely to be associated with high (low) accrual quality. Value stocks earn higher returns mainly in down markets, while poor accrual quality firms have significantly higher returns during up markets, but significantly lower returns during down markets. There is a significant interaction effect between accrual quality and the value premium, which only exhibits in the down markets (i.e. stocks with poor accrual quality earn a higher value premium in down markets than stocks with good accrual quality).
Originality/value
Results in this paper help disentangle between various explanations proposed for the accrual quality premium and the value premium. These findings are consistent with the idea that the same underlying risk factor generating the value premium also generates the cross‐sectional variation in accrual quality responsible for the accrual quality premium. From the corporate managers' perspective, the results imply that value firms can mitigate their higher costs of capital by providing high quality of accounting information. From an analyst's perspective, the study suggests that considering both accrual quality and growth characteristics can help make better portfolio allocation decisions than when these are considered separately.
Details
Keywords
The purpose of this paper is to offer a “how to” guide for applying Merton’s (1987) valuation adjustment for incomplete information, which depends on market capitalization…
Abstract
Purpose
The purpose of this paper is to offer a “how to” guide for applying Merton’s (1987) valuation adjustment for incomplete information, which depends on market capitalization, idiosyncratic risk and extent of investor ownership.
Design/methodology/approach
The paper illustrates Bodnaruk and Ostberg’s (2009) formula for Merton’s adjustment, and presents some example empirical estimates of the adjustment for some US stocks.
Findings
The adjustment estimates are material for many example stocks, particularly volatile stocks with a low percentage of shares held by institutional funds. However, the adjustment estimates are modest for many other stocks, including some smaller cap. stocks.
Research limitations/implications
Measuring the model’s inputs requires using some judgment, particularly regarding the investor ownership variable. The paper will hopefully help stimulate useful empirical research on adjustment estimates and on best practices for applying the model.
Practical implications
The paper may encourage more use of the incomplete-information adjustment in practice, which should lead to improved discount rate estimates in valuation analyses.
Originality/value
No other “bridge the gap” coverage of the incomplete-information adjustment is available in textbooks or the applied literature.