Why the Fundamental Relation between Firm Market and Accounting Values Is Log-Linear

50 Pages Posted: 1 Nov 2017 Last revised: 13 May 2018

See all articles by Martien Jan Peter Lubberink

Martien Jan Peter Lubberink

Victoria University of Wellington - Te Herenga Waka - School of Accounting and Commercial Law

Roger J. Willett

Victoria University of Wellington - Te Herenga Waka - Victoria Business School

Date Written: October 31, 2017

Abstract

We provide a solution that may offer closure to the question on how to measure the empirical relation between stock market values and accounting numbers. The models that dominate studies of the relevance of accounting numbers produce coefficient estimates that are hard to interpret and exhibit great volatility. We present a theory that demonstrates a multiplicative power law describes the long-run relation between market values and accounting values. Consequently, the correct forms for estimating the market-accounting relations are log-linear. Crosssection models based on this theory produce elasticities that are valid and accurately reflect the value relevance of accounting variables. We estimate these elasticities in the cross-section for the years 1971-2016. We compare our multiplicative model, log-linear, estimates to response parameters of traditional, additive-linear models that relate market and accounting values. Our results demonstrate the superiority of using elasticities to measure the empirical relation between market values and accounting numbers.

Keywords: Fair Values, Fundamentals, Log-Linear Models, Value Relevance

JEL Classification: C10, C46, M41

Suggested Citation

Lubberink, Martien Jan Peter and Willett, Roger J., Why the Fundamental Relation between Firm Market and Accounting Values Is Log-Linear (October 31, 2017). Available at SSRN: https://ssrn.com/abstract=3062425 or http://dx.doi.org/10.2139/ssrn.3062425

Martien Jan Peter Lubberink (Contact Author)

Victoria University of Wellington - Te Herenga Waka - School of Accounting and Commercial Law ( email )

New Zealand
+64 4 463 5968 (Phone)

Roger J. Willett

Victoria University of Wellington - Te Herenga Waka - Victoria Business School ( email )

PO Box 600
Wellington 6140
New Zealand

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