The effects of persistence, growth, and conservative accounting on the association of accounting information with market value

Prior research by Ohlson (1995), Feltham and Ohlson (1995), Feltham and Ohlson (1996) and more recently Zhang (2000) model firm value as a function of earnings (net of dividends) and book value. The relative importance of earnings and book value in these models depends on such factors as earnings persistence and conservatism, among others. The conservatism can be caused by positive net present value investments (measured as asset growth) and conservative accounting methods. The effects of these factors on the weighting of earnings and book value are unclear, since the theoretical predictions differ across the literature. I empirically test these effects and find the weighting of earnings, relative to book value to be higher when earnings persistence is high, consistent with predictions of Ohlson (1995) and Feltham and Ohlson (1995). I also find the weighting of earnings, relative to book value to be higher when asset growth is high, consistent with the prediction of Zhang (2000). Finally, I find the weighting on earnings to be higher when the level of conservatism caused by conservative accounting methods is higher, consistent with the price to book ratio (a measure of conservatism) expectations of Zhang (2000). Additionally, I find that this adjustment to earnings for conservatism from conservative accounting methods increases with growth. However, I find no evidence to support that the weight on book value has an offsetting lower weighting when the level of conservatism caused by conservative accounting methods is higher. Together, these results suggest the descriptive validity of the existing literature is limited in modeling how earnings persistence, asset growth and conservative accounting methods affect the relative importance of earnings and book value in valuation.