Accounting Information and Equity Returns: A Derivative of the Value Function

Abstract

Having examined the relation between equity value and accounting data, we now shift the focus of discussion to equity return. Returns arise from changes in value (plus dividends); so the return function is a derivative of the value function. We continue to use the ROM framework in this chapter. Our objective is to gain a better understanding of how equity returns relate to specific accounting variables that convey a firm’s value generating activities.

Appendix A: Variable Measurement for Empirical Analysis

The stock return (R _t ) is the return from 2 days after the prior year’s earnings announcement to 1 day after the current year’s earnings announcement; earnings yield (x _t ) is earnings (X _t ) divided by the beginning-of-period market value of equity (V _t-1 ); profitability change $( \Delta {roe_{it }})$is year t profitability ROE _t minus year t-1 profitability, ROE _t-1 , multiplied by the beginning-of-period book-to-market ratio (B _it-1 /V _it-1 ); capital investment $(\Delta {b})$is the change in the book value of equity relative to the prior year multiplied by (V _it-1 /B _it-1  − 1)/V _it-1 ; growth opportunity change ($\Delta {g_{it }}$) is the change in the median analyst forecast of the long-term growth rate following the current year earnings announcement relative to that of the prior year multiplied by B _it-1 /V _it-1 ; discount rate change ($\Delta {r_{it }}$) is the change of the 10-year US Treasury bond yield over the return period multiplied by B _it-1 /V _it-1 .