Accounting Standard-Setting Organizations and Earnings Relevance: Longitudinal
Evidence from NYSE Common Stocks, 1927-93
by
Kirsten Ely
(Emory University)
and
Gregory Waymire
(University of Iowa)
Current Draft: April 1998
Key Words: Accounting standards; capital markets, earnings.
JEL Classification: G18, M41, N22, N82.
1
We want to thank George Benston, Bill Cready, Ron King, Carla Hayn, Paul Irvine,
Baruch Lev, Grace Pownall, Gord Richardson, Paul Simko, workshop participants at
NYU, UCLA, Washington (St. Louis), and Emory and an anonymous referee for their
helpful suggestions on prior drafts of this paper. Generous financial support for this
research was provided by the Goizueta Business School of Emory University.
2
1.0 Introduction
In this paper we report evidence on the relevance of earnings for valuation of
NYSE common stocks from 1927 - 93. For each sample year, we select a random sample
of 100 NYSE firms (excluding transportation firms, financial institutions, and public
utilities) and measure the strength of association between earnings and stock returns (the
adjusted R2 of a cross-sectional regression of 16-month stock returns on annual earnings
changes and levels - see Lev [1989]). Based on a time series analysis of this measure, we
investigate whether earnings relevance has increased following: (1) the empowerment of
the Committee on Accounting Procedure (CAP) in 1939 as the first U.S. standard-setting
body, and (2) subsequent reorganizations of the standard-setting process which led to the
establishment of the Accounting Principles Board (APB, 1959-73) and the Financial
Accounting Standards Board (FASB, 1973-Present).
We focus on earnings relevance since income measurement and disclosure has
been a primary (although not exclusive) focus of accounting policymakers throughout the
period covered by our study. In the early 1930’s, when the AIA (forerunner of the
AICPA) recognized the need for policies which required the disclosure or standardization
of accounting methods, they emphasized the “cardinal importance” of income as
“explained by the fact that the value of a business is dependent mainly on its earning
capacity” (see AIA [1934, p.9]). Over 40 years later, the FASB in SFAC1 adopted a
similar view when it concluded that: (1) an objective of setting standards is to enhance the
relevance of accounting data, and (2) the primary focus of financial reporting is on
3
earnings and its components (see FASB [1978]). Consistent with this, earnings is seen as
a primary determinant of share prices by the financial community.1
We examine NYSE firms both because data are available for these firms over the
lengthy time series we examine and these firms were the primary target of the Securities
Exchange Act of 1934 under which private-sector standard-setting bodies have derived
their authority.2 Our longitudinal approach allows us to track the time series behavior of
earnings relevance for NYSE common stocks from a regime without accounting standards
(pre-1939) through the formation of the CAP as well as subsequent reorganizations that
led to the establishment of the APB and FASB. Because one of the AIA’s early goals was
to enhance the quality of accounting data for assessing earning capacity, we hypothesize
an increase in earnings relevance following the CAP’s empowerment. We test for
increased earnings relevance following subsequent reorganizations since the objective of
each reorganization was to improve on the existing standard-setting body.
While standard-setters may believe that enhancing relevance is desirable, there can
be significant impediments to achieving such a goal. Informational relevance is likely a
complex, multidimensional attribute and standard-setters may not reach consensus on
1
Accounting earnings is regularly forecasted by financial analysts, its use in summary valuation measures
is widespread (e.g., price-earnings ratios), and it is typically one of the first items reported in prominent
financial press outlets such as The Wall Street Journal when firms’ financial results are disclosed. The
primary importance of earnings in equity valuation has long been emphasized in texts on security analysis
and equity valuation (see Graham and Dodd [1934] and Palepu, Bernard, and Healy [1996]).
2
Monthly returns data are available for NYSE stocks in machine-readable form extending back to the
mid-1920’s. Income statement data are available on COMPUSTAT back to the mid-1950’s and Moody’s
manuals provide extensive accounting data over the entire period covered by our study. The Securities
Exchange Act of 1934 also applied to firms traded on the Curb Exchange (forerunner of the American
Stock Exchange), but the total market value of these stocks was small relative to the NYSE (see Bernheim
and Schneider [1935]). Federal securities law mandating public disclosure was not extended to OTC
markets until the 1960’s.
4
which specific methods will enhance relevance (see Joyce, Libby, and Sunder [1982] and
Dye and Verrecchia [1995]). Second, the relevance of accounting data may be influenced
by changes in the economic environment beyond the standard-setter’s control (see Lev
[1996]).3 Hence, they may play a continual game of “catch-up” where new standards are
required merely to keep pace with changing external circumstances. Finally, standardsetting is a political process (see Watts and Zimmerman [1978] and Miller and Redding
[1988]). As such, standard-setters may be required to trade-off relevance against the need
to satisfy multiple constituencies with conflicting interests. These (and other) factors
could work against our finding increased earnings relevance following empowerment of
the CAP and subsequent reorganizations of the standard-setting process.
Our analyses provide little evidence to suggest that the mean and median adjusted
R2 (as well as its trend) from yearly returns-earnings regressions are significantly higher
following empowerment of the CAP in 1939 and subsequent reorganizations leading to
creation of the APB and FASB. We find weak evidence of a higher median during the
CAP’s tenure (1939-59) compared to the Pre-CAP era (1927-38), but this result is not
robust under alternate specifications of our primary tests where either yearly rank
regressions are used, losses are excluded from the sample, or operating income is used in
lieu of net income in the yearly regressions. Differences in means and medians are not
significant in comparisons across four successive time periods: Pre-CAP (1927-38), CAP
(1939-59), APB(1960-73), and FASB (1974-93).
3
For example, the AICPA’s Jenkins Committee concluded that the relevance of financial statements has
declined in recent years due to changes in the business environment (see AICPA [1994]). The studies by
Collins, Maydew, and Weiss [1997], Francis and Schipper [1996] and Lev [1996] all provide evidence on
this issue.
5
We also estimate yearly models where stock price is regressed against earnings and
book value since Collins, Maydew, and Weiss (CMW) [1997] and Francis and Schipper
(FS) [1996] use this model in longitudinal analyses of the relevance of financial statement
data from the mid-1950’s to the early 1990’s. The evidence in CMW and FS indicates
that the combined relevance of earnings and book value has increased during this period
while the incremental relevance of earnings (book value) has declined (increased) over the
same period. Their results raise the possibility that tests focused solely on earnings may
understate the impact of standard-setters since new standards can have an impact on the
balance sheet as well as the income statement.
Results from tests examining incremental earnings relevance in price regressions
are consistent with our earlier results based on returns regressions: we find no evidence
indicating that the valuation relevance of earnings has significantly increased since the
initiation of U.S. standard-setting in 1939. Consistent with evidence in CMW and FS, we
document a highly significant increase in the combined relevance of earnings and book
value during the FASB’s tenure compared to the APB era which is driven by increased
incremental relevance of book values. However, this increase in combined relevance is
largely the artifact of abnormally low combined relevance in the APB era. For instance,
the combined relevance of earnings and book value is the lowest in our sample period
during the years of the APB’s tenure (1960-73) and the combined relevance of earnings
and book value in the FASB era is not significantly different than that observed during the
Pre-CAP and CAP periods.
In sum, our evidence provides only weak support for the hypotheses that earnings
relevance is higher following the introduction of U.S. accounting standard-setting bodies
6
and subsequent reorganizations of the standard-setting process. However, it should be
stated at the outset that our analysis is based entirely on broad tests of association and we
cannot offer causal inferences about economic factors which underlie these weak findings.
We offer some suggestions for future research in the concluding section of this paper in
the hope that further analyses will produce a clearer understanding of our findings.
The rest of the paper is organized as follows. We present our hypotheses in
section 2. Section 3 describes sample selection and test design. Empirical evidence is
reported in section 4 and the paper is summarized in section 5.
2.0. Hypotheses
Congress established the SEC in 1934 and granted it authority to determine both
the accounting methods and disclosures required for corporate financial reports. The SEC
delegated the establishment of accounting principles to the private sector in 1938 (see
Cooper and Robinson [1987]). One year later, the American Institute of Accountants
(AIA) reorganized an existing committee to form the Committee on Accounting
Procedure (CAP) and empowered it to develop accounting policy pronouncements (see
Zeff [1984, pp. 453-8]).4 The CAP was replaced in 1959 by the Accounting Principles
4
Limited efforts to develop accounting principles were attempted prior to establishment of the SEC but
these had little impact on most firms. In 1917 the AIA worked with the Federal Trade Commission to
develop a set of accounting and auditing guidelines, but firms were not required to follow these guidelines
(see Moonitz [1970]). The AIA also worked with the NYSE to develop a set of five basic principles in the
early 1930’s (see Carey [1969, p. 176]). These were not immediately adopted by NYSE firms since
changes to existing listing arrangements can be made only when firms issue new securities (see Shultz
[1936] for the history of NYSE listing agreements in the pre-SEC era).
7
Board (APB). The APB was replaced in 1973 by the Financial Accounting Standards
Board (FASB).
We investigate two primary hypotheses related to the establishment and
subsequent reorganizations of the U.S. accounting standard-setting process. The first is
whether earnings relevance is higher following the establishment of the CAP in 1939.
Tests of this hypothesis are directed towards comparing earnings relevance in a regime
with accounting standard-setting bodies to one where no such bodies exist. The second
hypothesis concerns whether subsequent reorganizations of the standard-setting process in
1959 and 1973 are followed by higher earnings relevance. Tests of this hypothesis
compare earnings relevance under the APB and FASB with earnings relevance under their
respective predecessors - i.e., the APB (1960-73) is compared to the CAP (1939-59) and
the FASB (1974-93) is assessed using the APB as a benchmark.
The motivation for our first hypothesis stems from the view that standard-setting
bodies seek to enhance the relevance of accounting data to financial statement users (see
Dyckman [1988] for a discussion of alternative views of accounting standards). Prior to
1939, two ways of enhancing relevance through standard-setting were debated (see AIA
[1934, p. 7]). The first does not alter existing practice, but provides information on
alternative methods employed in practice and requires disclosure of the methods used by a
firm. The CAP’s approach to standard-setting resembled this approach (see Zeff [1984,
pp. 453-8]). The second was one where the standard-setter selects a single method to be
used by all companies. This is the approach followed later by the APB and FASB.
8
While the CAP did not advocate major changes to existing practice, their activities
could still increase the relevance of earnings for equity valuation. Early texts on security
analysis suggest that comparing earnings across firms was difficult due to the lack of
disclosure of accounting methods (see Graham and Dodd [1934, pp. 350-5]). If the CAP
increased investors’ knowledge through expanded disclosure of accounting methods, then
cross-firm comparisons would be facilitated and it is less likely that firms could misstate
earnings in a manner which would not be detectable. In turn, investors would (all else
equal) place greater emphasis on earnings in valuing corporate equity.5
Hence, we test our first hypothesis comparing earnings relevance under the CAP
to that observed in the pre-CAP period (1927-38). We test this hypothesis against a onetailed alternative which permits rejection of the null only if earnings relevance is higher
during the CAP era compared to the Pre-CAP period. We also test this hypothesis by
comparing earnings relevance in the Pre-CAP period with that observed for all years in
our sample period where a standard-setting body exists (i.e., 1939-93). In both cases, a
one-tailed alternative is used since it is difficult to envision circumstances under which a
standard-setter would actively seek to reduce the relevance of accounting information to
financial statement users. As noted at the outset, the objective of improving relevance is
one which has been consistently stated by policymakers (see AIA [1934] and FASB
[1978]).
5
Financial historians have argued that early 20th century investors placed far greater emphasis on
dividends than earnings in equity valuation because earnings were subject to manipulation (see Baskin
and Miranti [1997, pp. 188-99]). Sivakumar and Waymire [1993] report evidence indicating that
announcements of dividend changes by NYSE industrials during 1905-10 are associated with larger
magnitude stock price changes than announcements of annual earnings changes.
9
Our second hypothesis is whether reorganizations of the standard-setting process
leading to establishment of the APB in 1959 and the FASB in 1973 are followed by
periods of increased earnings relevance. Both reorganizations were intended to address
three issues about the standard-setting process first raised by critics of the CAP in the
1950’s (see Zeff [1984, pp. 458-62]). First, the CAP did not adopt accounting principles
that could enhance comparability by reducing diversity in accounting practice. Second,
they did not develop a theoretical framework to direct the selection among alternative
accounting methods. Such a framework may enhance a standard-setter’s ability to write
relevance-enhancing standards by providing a more focused, proactive strategy for
standard-setting that is linked to specific objectives such as enhanced relevance. Third,
the CAP failed to win corporate support for their pronouncements while maintaining
independence. Obtaining support from multiple constituencies may be important to avoid
passing “watered down” standards that have little effect on the quality of accounting
information.
The APB adopted a more normative approach to standard-setting than the CAP
and succeeded in reducing the diversity of practice in some areas. This was accomplished,
in part, by making it more difficult for firms to use methods of accounting other than those
sanctioned by the standard-setter. In the mid-1960’s, the AICPA began requiring that
auditors disclose departures from APB Opinions in their reports or in the footnotes to the
financial statements (see Davidson and Anderson [1987, p. 118]). If this reduction in
diversity of accounting practice made earnings data reported by firms more comparable,
we would expect that earnings relevance would be greater under the APB than under the
CAP.
10
At the same time, the APB failed to address two of the three criticisms that had
been raised about the CAP. While the APB attempted to write a conceptual framework,
they did not successfully complete this task (see Davidson and Anderson [1987, p. 117]).
Also, despite having adopted more extensive due process procedures than the CAP, delays
in writing accounting rules for business combinations (APB Opinions 16 and 17)
combined with intense pressure from industry groups led some to question whether the
APB could remain independent while reaching consensus on new standards which win the
support of multiple constituencies.6
The reorganization which created the FASB was the result of continuing
dissatisfaction over these two issues. The AICPA formed two committees to separately
examine the conceptual underpinnings of accounting and the organization of the standardsetting process. The Trueblood Committee was charged with studying the objectives of
financial reporting in the hopes of making further progress towards a conceptual
framework. The Wheat Committee, charged with studying the institutional processes used
to establish accounting standards, recommended a major restructuring of the standardsetting process (see “Recommendations of the Study on the Establishment of Accounting
Principles,” Journal of Accountancy [1972]).
The FASB built on the final report of the Trueblood Committee (see AICPA
[1973]) in its own Conceptual Framework project.7 Under their Conceptual Framework,
6
Unlike the CAP, the APB distributed exposure drafts of proposed opinions and held public meetings
with industry groups (see Zeff [1984, p. 462]).
7
See FASB [1991] for the text of the six Statements of Financial Accounting Concepts comprising their
Conceptual Framework. There has been debate on the effectiveness of the FASB’s Conceptual
Framework (see Dopuch and Sunder [1980] and Daley and Tranter [1990]).
11
one primary objective of the standard-setting process is to enhance the relevance or
usefulness of accounting information to financial statement users (see SFAC1).8 The
stated purpose of the FASB’s framework is, in part, to provide a basis for selecting among
alternative methods to enhance informational relevance. Using this framework as a basis,
the FASB has continued the APB’s attempt to reduce diversity in accounting practice.
This approach was further legitimized by the SEC in 1973.9
The restructuring recommended by the Wheat Committee led to the FASB being
structured differently than the APB on some dimensions that may affect its ability to
promulgate relevance-enhancing standards. The FASB was established independently of
the AICPA (both the APB and FASB were part of the AICPA) and its membership
represents a broader set of constituency groups.10 The FASB also has fewer members
(seven vs. over 20 for both the CAP and APB) and these members serve full-time (CAP
and APB members retained full-time careers outside their role as standard-setters). These
structural changes were intended to help board members identify issues pertinent to
multiple constituencies, maintain independence from previous employers, and resolve
disagreements.
8
The definition of relevance in the FASB Conceptual Framework is more narrow than the one we employ.
They view relevance as determined jointly by informational predictability, feedback ability, and
timeliness. We study the broader notion of information usefulness to financial statement users as defined
by the association between information and prices (see Lev [1989]). Our definition is consistent with that
employed in other recent studies by Collins, Maydew, and Weiss [1997], Francis and Schipper [1996],
and Lev [1996] on changes in the relevance of accounting information over time.
9
SEC Accounting Series Release No. 150 asserts that FASB standards have substantial authoritative
support and should be used by firms in preparing financial statements submitted to the SEC under federal
securities laws.
10
Seats on the FASB are allocated to a broader group of constituencies which include academics,
preparers, and users of financial statements. The FASB also has adopted far more extensive due process
procedures for evaluating proposed standards than the APB. Miller and Redding [1988, pp. 31-82]
provide a description of the organizational structure and processes of the FASB.
12
While it is difficult to assess the effectiveness of these structural changes, the
FASB has survived longer and issued more pronouncements than either the CAP or APB.
Through the end of 1993 (the final year in our sample period), the FASB had promulgated
117 Standards (an average of 5.5 from 1974-1993). In contrast, the CAP wrote 51
Accounting Research Bulletins (average of 2.4 per year from 1939-59) and the APB
penned 31 Opinions (average of 2.2 per year). 11 If the FASB’s Conceptual Framework
and process changes increase the likelihood of promulgating relevance-enhancing
standards, then the relevance of earnings will be higher under the FASB than the APB.
We test our second hypothesis by comparing earnings relevance under the APB
and FASB with their respective predecessors. As with our first hypothesis, we test against
a one-tailed alternative permitting rejection of the null only when relevance is higher than
under the prior standard-setting organization. In other words, we assess whether earnings
relevance is higher under the APB than the CAP and for the FASB compared to the APB.
We may be unable to reject either our first or second null hypothesis since the
ability of standard-setters to write relevance-enhancing standards can be limited for several
reasons. First, the underlying relation between accounting standardization and
informational relevance may be complex. For instance, Dye and Verrecchia [1995]
develop a theoretical model which shows that the impact of limiting accounting discretion
on the value of accounting data will depend on the nature of conflicts both between
managers and shareholders (the internal agency problem) as well as current and future
11
The FASB average is higher, in part, due to a high number of pronouncements during the four years
between 1979 and 1982. Excluding the 47 Standards adopted in this period, the average for the FASB
would drop to 4.4 per year (which is still approximately twice the average annual number of
pronouncements by the CAP and APB together).
13
shareholders (the external agency conflict). Also, even if all parties had identical
incentives, experimental evidence suggests it is not a straightforward task for standardsetters to unambiguously identify accounting rules that will result in more relevant
accounting information (see Joyce, Libby, and Sunder [1982]).
Second, some have recently argued that the information in financial reports is
becoming less relevant (in relative terms) to investors due to increased complexity of the
business environment. This view led the AICPA’s Jenkins Committee to recommend
development of an expanded model of business reporting which places greater emphasis
on forward-looking and nonfinancial information (see AICPA [1994]). Lev [1996]
presents a similar argument and provides some evidence consistent with this conjecture.
The effect of environmental change (beyond the standard-setter’s control) which erodes
the relevance of accounting data is that standard-setters may need to write new standards
at an accelerating rate merely to maintain the overall relevance of accounting data at
existing levels. If these effects exist, any improvements in relevance from new standards
may be offset by an underlying negative trend caused by environmental change.12
Finally, standard-setting is a political process where competing constituencies
attempt to influence the process towards the adoption of rules which favor their self
interest (see Watts and Zimmerman [1978] and Miller and Redding [1988]). Competing
political interests will reduce the standard-setter’s ability to adopt relevance-enhancing
standards. Moreover, the effect of political pressure could actually be heightened by the
12
In addition to Lev [1996], Collins, Maydew, and Weiss [1997] and Francis and Schipper [1996] also
provide evidence suggesting that the association between earnings and prices has eroded in recent years.
These latter two studies document that the declining relevance of earnings in recent years has been offset
by increased relevance of balance sheet data. We address this issue in section 4.
14
use of elaborate due process procedures (such as those used by the FASB) as lengthy
debate results in delays in adoption of new standards or weakens the standards eventually
adopted. One example of this would be the FASB’s standard on accounting for stock
options which took several years to complete and differed markedly in final form from the
initial exposure draft (see Loomis [1988]).
3.0. Sample Selection, Data, and Methodology
For each of the 67 years during 1927-93 (inclusive), we randomly select 100
NYSE companies from the CRSP Monthly Price File that meet the following criteria: (1)
the firm has monthly common stock price data available for the 29 months from February
of the prior calendar year through June of the subsequent calendar year, and (2) the firm’s
four-digit SIC code is between 1000 and 3999. The first criterion is imposed to insure
sufficient data to estimate the stock return variables used in our empirical tests. The
second criterion excludes railroads, utilities, and financial institutions, all of which are
subject to regulatory processes that can influence their earnings numbers.
Data on firms’ annual earnings are collected from either COMPUSTAT or
Moody’s manuals on industrial securities. All data from before 1950 have been manually
collected from Moody’s. When COMPUSTAT data are not available for a firm in the
post-1950 period, we collect data applicable to that firm-year observation from Moody’s.
13
13
We did not condition the selection of firms on COMPUSTAT data availability since the coverage of
firms is considerably thinner in the 1950’s than today. Only 47% of the firms entering our samples for
15
We found no usable earnings data for 30 of 6,700 firm-year observations. To
maintain consistency of the random selection process, we did not replace these
observations. More of the missing observations occur in the pre-1951 period (preCOMPUSTAT) than in the post-1950 period (18 vs. 12). There are no more than three
missing observations in any given year. Of these 30 cases, two observations are missing
because we cannot find information for the firm in either COMPUSTAT or Moody’s.
Changes in fiscal year-end account for 18 of these observations and insufficiently detailed
disclosures account for ten.
Our primary tests examine the explanatory power of yearly cross-sectional
regressions of 16-month market-adjusted stock returns on annual earnings changes and
levels.14 We use both earnings changes and levels since the inclusion of levels improves
specification of the earnings-return relation (see Easton and Harris [1991] and Ali and
Zarowin [1992] for evidence and Ohlson and Schroff [1991] for theory). The marketadjusted return equals the difference between the firm’s return over this interval and the
return on the CRSP equally-weighted index of NYSE stocks. For each of the 67 years in
our sample period, we estimate the following cross-sectional model:
ri = γ0 + γ1 ∆Ei + γ2 Ei + εi
(1)
the years 1950-59 have data available on COMPUSTAT. The percentage of firms in our sample with data
on COMPUSTAT increases with time. For example, the percentage of firms with COMPUSTAT data
available are 50, 92, 95, and 99 in 1960, 1970, 1980, and 1990, respectively.
14
If reporting lags are substantially longer in the early part of our sample period, a bias could be
introduced in favor of our alternative hypotheses by the use of a return measurement interval that did not
allow for the full incorporation of earnings information into prices. The effect of such a bias is likely of
second-order magnitude, at best. For example, Sivakumar and Waymire [1993] document an average
reporting lag of nearly 11 weeks for NYSE firms in 1905-10 compared to average lags of nine and six
weeks respectively for 1960 and 1974 reported by Givoly and Palmon [1982]. Hence, the use of a 16month return measurement interval will likely include the actual earnings announcement date for most of
our sample firms, even for early years in our sample period.
16
where
ri = 16-month market-adjusted return for firm i measured from the first
month of the fiscal year through the end of the fourth month after the
fiscal year end,
∆Ei = change in annual earnings for firm i scaled by the beginning of period
market value,
Ei = annual earnings for firm i scaled by the beginning of period market
value, and
εi = residual term.
We examine the adjusted R2 (i.e., the proportion of the market-adjusted return
associated with annual earnings) as a measure of earnings relevance (see Lev [1989]).
Because returns are measured over a 16 month interval, the adjusted R2 reflects a
statistical association rather than the degree to which investors actually use earnings in
establishing equity values.
Inspection of the data indicates the existence of some extreme observations that
likely constitute outliers. We eliminate from the sample 79 observations where either the
dependent variable or one of the independent variables in eq. (1) is six or more standard
deviations away from the mean for that variable in the yearly sample to which the
observation applies.15 After excluding these 79 observations and the 30 cases with no
useable earnings data, the final sample on which our subsequent analyses are based
includes 6,591 firm-year observations.
15
This loss of 79 observations represents 1.2% of the total 6,670 observations for which data are available.
These observations are not clustered in a particular period; the number of observations excluded in each
period is: 15 (Pre-CAP, 1927-38), 22 (CAP, 1939-59), 19 (APB, 1960-73), and 23 (FASB, 1974-93).
17
Estimation results for eq. (1) using the 67 yearly samples indicate a mean (median)
adjusted R2 of .185 (.169) and the measure is positive in all 67 years. Using an F-test, the
overall regression is significant at the .10 level in 65 (97%) years.16 Consistent with prior
research, the mean and median coefficients are positive for both independent variables.
Earnings level coefficients are positive and significant at the .10 (.05) level in 45 (41) years
compared to 37 (30) years for earnings changes. These estimation results suggest that
earnings is a significant factor in explaining cross-sectional return variation for our yearly
samples and this effect is present for virtually all years in our sample period.
4.0. Empirical Evidence
4.1. Primary Results
Panel A of table 1 shows the mean and median adjusted R2 based on yearly
estimation of eq. (1) for 1927-93 partitioned into four sub-periods: Pre-CAP (1927-38),
CAP (1939-59), APB (1960-73), and FASB (1974-93). The test statistics (either a tstatistic for the means or a Wilcoxon z-statistic for medians) shown under the CAP, APB,
and FASB means and medians are used in one-tailed tests for differences relative to their
respective predecessor regimes. The statistics under the means and medians for the “All
16
Without eliminating extreme observations, the mean (median) adjusted R2 is .142 (.118) and the overall
regression is significant at the .10 level in only 56 years. We selected a six standard deviation cutoff
because this was the point at which improvement in model performance (as measured by the number of
years where the regression was significant) was largely exhausted and the overall loss of data from
imposing the deletion rule remained small. For example, using a three (two) standard deviation rule
would have resulted in 64 (64) significant years and the overall loss of observations would have been N =
294 (593).
18
Bodies” period (1939-93) apply to a one-tailed comparison with the Pre-CAP period
(1927-38).
_______________________________
Insert Table 1 About Here
_______________________________
Our first hypothesis (in alternative form) is that earnings relevance is higher
following empowerment of the CAP in 1939. This hypothesis is tested by comparing the
mean and median adjusted R2 in the Pre-CAP period (1927-38) with either: (1) the CAP
period (1939-59), or (2) the entire period covered by U.S. standard-setting bodies (193993). Our second hypothesis (in alternative form) is that earnings relevance will be higher
following establishment of the APB (FASB) in 1959 (1973). We test this hypothesis by
comparing adjusted R2 levels in: (1) the APB period with those of the CAP period, and (2)
the FASB era to those during the APB’s tenure.
These comparisons provide only weak support for our first alternative hypothesis.
During the CAP era, the median adjusted R2 equals .2312 compared to .1570 in the PreCAP period (a Wilcoxon test rejects the null of equal medians at the .05 level). No other
test of means or medians permits rejection of either null hypothesis at the .10 level.
Hence, the evidence in panel A does not support the hypothesis that relevance is
significantly higher after the reorganizations creating the APB and FASB, but there is
weak support for higher earnings relevance in the CAP era compared to the Pre-CAP era.
One limitation of the tests in panel A is that they do not capture changes in
earnings relevance that occur throughout a given standard-setting body’s tenure. To
19
illustrate, the assertion that standard-setters can enhance earnings relevance assumes that
each new standard improves the quality of accounting earnings and makes these data more
relevant to investors. If this is true, then earnings relevance should be increasing during
the standard-setting body’s tenure as it promulgates new standards - i.e., the effect of new
standards on earnings relevance should be cumulative. Moreover, if the standard-setting
body in place improves on the prior regime, the upward trend in relevance over its tenure
should be greater than that associated with the prior regime. To investigate this
possibility, we estimated the following time series model which allows for an upward trend
in earnings relevance during a standard-setting body’s tenure:
ARSQt = δ0 + δ1 τt + δ2 Dt τt + ut
(2)
where
ARSQt = adjusted R2 of cross-sectional regression of market-adjusted
returns on earnings levels and changes for year t,
τt = trend variable equal to one for 1927, two for 1928, and so forth, and
Dt = dummy variable assuming a value of one under the regime
hypothesized to have increasing relevance and zero otherwise.
Eq. (2) is estimated for our first test of hypothesis one using data from the 33
years during 1927-59. For this test, Dt assumes a value of one for all years between 1939
and 1959 inclusive. If earnings relevance is increasing during the CAP’s tenure beyond
the rate during the pre-CAP period, then δ2 will be positive. In the test comparing the
Pre-CAP period to the period covered by all bodies during 1939-93, Dt assumes a value of
one (zero) for all years 1939 and beyond (during 1927-38). In testing hypothesis two, we
20
estimate eq. (2) over either: (1) the 1939-73 period to compare the APB with the CAP, or
(2) over the 1960-93 period in comparing relevance under the APB and FASB.
Trend model results are shown in panel B of table 1. None of the four estimates of
δ2 is significant at the .10 level or better based on a one-tailed t-test.17 These results do
not indicate an upward trend in earnings relevance for periods following the CAP’s
empowerment or subsequent reorganizations leading to establishment of the APB and
FASB.
As a diagnostic test, we also replicated the tests in table 1 using yearly rank
regressions to estimate eq. (1). In these tests, we are unable to reject either null
hypothesis at the .10 level. The mean (median) adjusted R2 based on yearly rank
regressions during each of the four periods is: Pre-CAP: .2586 (.2852); CAP: .2798
(.2711); APB .2526 (.2400); and FASB: .2309 (.2263). Likewise, none of the coefficients
on the trend model in eq. (2) is significant at the .10 level when the yearly adjusted R2
values are based on rank regressions. Hence, the result in panel A that the median
adjusted R2 is higher in the CAP era is not robust to the use of rank regressions.
The means and medians from yearly adjusted R2 estimates in table 1 may be
influenced by only one or two years - i.e., an individual year’s estimate may be noisy since
it is based on no more than 100 observations. Hence, we also estimated eq. (1) where
observations are pooled across time to estimate a single regression for each of the four
17
Following Francis and Schipper [1996], we also estimated each trend model including an additional
independent variable to control for stock market volatility for the year in which the dependent variable
(adjusted R2) is measured. This variable was computed as the standard deviation for the 12 monthly
returns on the CRSP equally-weighted market index for the calendar year. This variable is not significant
in either model used to test hypothesis one in panel B of table 1, but it is positive and significant (at .05
level for two-tailed test) in both models used to test hypothesis two. However, inclusion of this variable
21
sub-periods (Pre-CAP, CAP, APB, and FASB). The adjusted R2 estimates from these
regressions are generally consistent with the results reported in panel A of table 1. For
these pooled regressions, the adjusted R2 increases from .1197 in the Pre-CAP era to
.1625 in the CAP period, but declines to .1427 in the APB era and .1047 during the
FASB’s tenure.18
We also investigated whether the time series behavior of the earnings relevance
measure differs for firms categorized by their relative size measured as the market value of
common equity at the beginning of the fiscal year. Firms were ranked on this measure
(within years) and split into two groups at the median. Firms above (below) the median
size are included in the group of relatively large (small) firms for that year. This test did
not reveal significant differences in the adjusted R2 levels across standard-setting regimes
for alternative samples defined by relative firm size.19
4.2. The Impact of Losses and Nonrecurring Items
We next investigated the impact of losses on our results since recent research
suggests that losses exhibit a weaker association with stock returns than positive earnings
(see Hayn [1995]). In a longitudinal study during 1953-93, Collins, Maydew, and Weiss
does not alter inferences about the trend coefficient δ2; in no case is this coefficient significant at the .10
level.
18
We tested for regression homogeneity between the Pre-CAP and CAP periods using a Chow test. This
test rejected at the .05 level, but this result should be interpreted cautiously since the Chow test will reject
either because of differences in explanatory power or differing coefficients between the two models.
19
The median adjusted R2 for relatively large firms is: .2269 (Pre-CAP); .2189 (CAP); .1129 (APB); and
.1206 (FASB) compared to .1546 (Pre-CAP); .2114 (CAP); .2074 (APB); and .1471 (FASB) for the
relatively small firms. The increase in the small firms’ median from the Pre-CAP to the CAP era is not
significant at the .05 level (Wilcoxon Z-statistic equals 1.25). Inferences are identical when hypotheses
are tested on means for these sub-samples.
22
(CMW) [1997] find that yearly measures of the relevance of accounting data are lower
when more firms report losses. The inclusion of loss observations could bias our tests in
either direction depending on their relative incidence in the four different time periods we
examine. For instance, the comparison indicating a higher median adjusted R2 in the CAP
period relative to the Pre-CAP period could be due to a higher frequency of losses in the
Pre-CAP period. Likewise, other tests failing to reject the null of increased earnings
relevance under subsequent standard-setting bodies could be due to a higher incidence of
losses in the later periods used in these comparisons.
The data in panel A of table 2 indicate that both the incidence and severity of
losses is relatively high in both the Pre-CAP and FASB periods. In the Pre-CAP era,
26.0% (304 of 1,171) of the earnings observations are losses and 13.2% of the
observations entering our yearly samples in the FASB era are losses. In contrast, only
4.6% and 4.7% of the observations for the CAP and APB periods, respectively, are losses.
The far right column of panel A shows the mean and median values of net income scaled
by beginning-of-year market value of equity for each of the four periods using loss
observations only. The mean (median) loss in the Pre-CAP sample of -.405 (-.185) is the
most negative of the four periods followed by -.235 (-.126) for the FASB sample.20 These
data suggest that the inclusion of loss observations in the sample may influence the results
of tests which examine the Pre-CAP and FASB eras.
20
The higher incidence of losses in the Pre-CAP era is not surprising since this period covers the Great
Depression of the early 1930’s. Macroeconomic research indicates that aggregate corporate earnings is a
leading indicator of cyclical changes in macroeconomic conditions (see Hall [1990, pp. 23-5]).
23
_______________________________
Insert Table 2 About Here
_______________________________
Panel B of table 2 shows replications of the tests in panel A of table 1 after
excluding losses for comparisons of: (1) the Pre-CAP and CAP periods, and (2) the APB
and FASB periods. The differences between the Pre-CAP and CAP periods’ mean and
median adjusted R2 levels are not significant at the .10 level. This suggests that the
significant difference in medians between these periods reported in table 1 is not robust to
the exclusion of losses from the sample. Excluding losses from the sample does not alter
inferences about the relative levels of earnings relevance under the APB and FASB.21
CMW also provide evidence indicating that yearly measures of informational
relevance are lower when the incidence of nonrecurring items is higher. The impact of
nonrecurring items on our results will depend on the magnitude of these items and their
directional impact on earnings. Items which are larger in absolute terms will have a
greater dampening effect on the adjusted R2 from the cross-sectional earnings-return
model. Also, nonrecurring items which reduce earnings should dampen the strength of
association between earnings and returns further since they increase the probability of a
bottom-line loss.
21
We also replicated all other tests previously reported in table 1 excluding losses. No conclusions, other
than those concerning differences in medians between the Pre-CAP and CAP periods, were altered by
excluding losses.
24
To avoid problems created by nonrecurring items, we also replicated our tests
using operating income in lieu of net income in the yearly cross-sectional returns
regression model. As with the analyses excluding losses, no significant increases in
earnings relevance across the sub-periods were detected. Using operating income in the
yearly regressions, the mean (median) adjusted R2 equals .1761 (.1161) in the Pre-CAP
period compared to .1868 (.1642) for the CAP sample. Neither the difference in the
means nor the medians between the Pre-CAP and CAP periods is significant at the .10
level. Likewise, no other replication of the tests in table 1 using operating income
permitted rejection of either null at the .10 level. 22
4.3. Tests on the Relevance of Earnings and Book Value
We also replicated our tests using an alternative yearly regression model where
stock price is regressed against earnings per share and book value per share. Both CMW
and FS use this model in longitudinal analyses of financial statement relevance from the
mid-1950’s to the early 1990’s and find that: (1) the combined relevance of earnings and
book value is increasing during this period, and (2) the incremental relevance of earnings
(book value) is declining (increasing) over this period. Their results suggest that tests
22
Estimation of the trend model in panel B of table 1 comparing the relevance of earnings under the PreCAP and CAP periods also did not reject the null for hypothesis one when using operating earnings in the
yearly models.
25
such as ours may understate the impact of standard-setters since new accounting standards
can also affect the relevance of balance sheet data as well as earnings.23
The following cross-sectional model is estimated for each of our 67 yearly
samples:
Pi = α0 + α1 Ei + α2 BVi + ui
(3)
where
Pi = cum-dividend price of common stock of firm i at the end of the fourth
month following the firm’s fiscal year end,
Ei = the annual earnings for firm i divided by the number of common
shares outstanding,
BVi = the book value for firm i divided by the number of common shares
outstanding, and
ui = residual.
We estimate eq. (3) using only firm-year observations which have passed a six
standard deviation filter on the dependent and independent variables similar to that
imposed in determining the yearly samples used in our returns tests. In total, 6,631 firmyear observations enter the yearly samples used for analyses based on eq. (3).24
23
We do not mean to imply that extending our tests to include book value is the only possible extension to
our tests. Other possibilities would be to investigate the valuation relevance of income statement and
balance sheet components or the supplemental information disclosed in footnotes. We focus on book
value because it (like earnings) is a convenient summary measure from a principal financial statement and
the results in CMW and FS suggest it may be important in longitudinal tests of the type we conduct.
24
From the original 6,700 firm-year observations, we eliminate 30 observations due to lacking earnings
data and another six due to lacking balance sheet data. The application of the six standard deviation
cutoff results in the loss of an additional 33 observations.
26
Following CMW, we use yearly estimates of eq. (3), along with univariate
regressions of either earnings or book value against price, to obtain measures of the
combined relevance of earnings and book value as well as measures of the incremental
relevance of earnings and book value. The combined relevance measure is the adjusted R2
of eq. (3). The incremental relevance of earnings (book value) equals the change in
adjusted R2 from adding earnings (book value) to a univariate price regression with only
book value (earnings) included initially as an independent variable. Stated alternatively,
the incremental relevance of earnings (book value) equals the adjusted R2 of eq. (3) less
the adjusted R2 from of a univariate regression of price against book value (earnings).
Table 3 provides summary information on the estimation of eq. (3) for the 67
yearly samples. Two points are noteworthy. First, the explanatory power of the yearly
price regressions is generally higher than the returns regression estimated earlier. The
mean (median) adjusted R2 of eq. (3) (shown in the row labeled the “regression with both
E & BV”) equals .4408 (.4619) compared to .185 (.169) for the returns regression.25 This
is due in part to the levels specification of the regression; the mean (median) adjusted R2
from a univariate regression of price against earnings equals .3791 (.3764), which is over
twice as large as the explanatory power of the returns regression.
_______________________________
Insert Table 3 About Here
_______________________________
25
Yearly estimates of eq. (3) provide a rejection of the null of no explanatory power at the .001 level using
an F-test in all 67 years.
27
Second, the earnings variable is more strongly associated with stock price than
book value. The earnings (book value) coefficient is positive and significant at the .05
level in 65 (35) years. Also, the mean and median incremental relevance measures for
earnings exceeds those of book value and the explanatory power of univariate regressions
based solely on earnings exceed those of book value. These results indicate the
importance of earnings for equity valuation and support our focus on earnings, at least as
a starting point for our sample and the time period we examine.
Table 4 shows mean and median relevance measures based on yearly estimates of
eq. (3) for the various time periods examined in our earlier tests. This table is laid out
similar to panel A of table 1 in that test statistics under the means and medians for the
CAP, APB, and FASB correspond to a comparison with the predecessor regime. The test
statistics applicable to the entire period of standard-setting bodies apply to a comparison
with the Pre-CAP period.
_______________________________
Insert Table 4 About Here
_______________________________
Four aspects of the results shown in table of 4 are worthy of mention. Note first
that the results on incremental earnings relevance are generally consistent with the
evidence based on yearly returns regressions. In only one comparison are the mean and
median higher for the latter period being compared. The mean (median) incremental
earnings relevance equals .2281 (.2204) in the APB period compared to .1840 (.1909) in
the CAP era. These differences are not significant at the .10 level. Hence, these tests
28
provide no evidence that earnings relevance in the CAP period is higher than in the PreCAP period. This is consistent with prior checks on the returns results; the finding of
higher median earnings relevance for the CAP period in table 1 is not a robust result.
Second, the results are consistent with evidence reported in CMW and FS
suggesting that the combined relevance of earnings and book value have increased during
the FASB era because of increases in the incremental relevance of book value. The mean
(median) combined relevance in the FASB era equals .4691 (.4707) compared to .3422
(.3009) in the APB period. These differences are significant at the .001 (.01) level for a
test of equal means (medians). The mean and median incremental relevance for book
value in the FASB period are also significantly greater than identical measures in the APB
era at the .001 level. Also consistent with CMW and FS, incremental earnings relevance
in the FASB era (mean of .1115 and median of .0992) is lower than in the APB era.
These differences would be highly significant in both cases under the application of twotailed tests.26
Third, the highly significant results on the combined relevance measure during the
FASB era are an artifact of relatively low combined relevance during the APB era rather
than abnormally high combined relevance in the FASB era. For instance, if two-tailed
tests were applied to the mean and median combined relevance in the APB era, both of
these measures would be significantly lower (at least at the .05 level) than the mean and
26
Also consistent with the evidence in CMW and FS, the combined relevance means and medians in the
APB and FASB eras increase when losses are excluded and differences across eras remain significant
(although at lower levels). Excluding losses, the mean (median) combined relevance in the FASB era is
.5038 (.5022) compared to .4153 (.4375) in the APB era. Both the differences in mean and median across
these periods are significant at the .05 level for a one-tailed test (t-statistic = 1.86 and Wilcoxon z-statistic
= 1.66). Excluding losses does not have a uniform effect of increasing the mean and median combined
29
median for the CAP era. Consistent with this, we applied identical significance tests in
comparing the FASB period against either the Pre-CAP or CAP periods on the combined
relevance measure. These results (not reported in a table) indicate no significant
differences between the FASB era and these earlier periods in terms of mean and median
combined relevance of earnings and book value.
Finally, a somewhat counterintuitive result in table 4 is the relatively strong
association between prices and accounting data in the period prior to the establishment of
U.S. standard-setting bodies. On all three relevance measures, we find no evidence of
increased relevance in the 1939-93 period compared to the Pre-CAP era. For all
comparisons, the mean and median relevance measure in the Pre-CAP exceeds that in the
1939-93 period and in the case of incremental earnings relevance, this difference is of
sufficient magnitude that it would be significant under a two-tailed test at the .001 level.
As a final check on the results, we also replicated the tests in table 4 using yearly
rank regressions. None of the combined relevance tests permit rejection of either null
hypothesis at the .10 level. The mean (median) combined relevance is.5280 (.5388) in the
Pre-CAP era, .5557 (.5718) in the CAP era, .5063 (.5067) in the APB era, and .5621
(.5524) in the FASB era. None of the inferences about incremental relevance of earnings
are changed by the use of rank regressions. The incremental relevance of earnings using
rank regressions falls significantly in the CAP and FASB eras and shows a significant
increase in the APB era while the incremental relevance of book value falls in the APB era
but increases in the FASB period. The median incremental relevance of earnings (book
value) is .3837 (.0283) for the Pre-CAP era, .2551 (.0138) in the CAP era, .3383 (.0002)
relevance measure across time periods. For example, the mean (median) in the Pre-CAP era falls from
30
for the APB period, and .2187 (.0391) in the FASB era. Mean incremental relevance
measures show a similar pattern.
5.0. Summary of Results and Suggestions for Future Research
Our objective in this paper has been to examine the time series behavior of the
valuation relevance of earnings for yearly samples of NYSE common stocks during 192793. For each of these 67 years, we measure the relevance of earnings as the adjusted R2 of
a cross-sectional regression model of 16-month market-adjusted returns on annual
earnings changes and levels. Our empirical tests investigate whether earnings relevance is
higher following: (1) empowerment of the Committee on Accounting Procedure (CAP) as
the first U.S. accounting standard-setting body in 1939, and (2) subsequent
reorganizations of the standard-setting process leading to creation of the Accounting
Principles Board (APB) in 1959 and the Financial Accounting Standards Board (FASB) in
1973.
The evidence we report provides only limited support for the hypothesis that
earnings relevance is materially higher after either empowerment of the CAP or
subsequent reorganizations of the standard-setting process. We find evidence of higher
earnings relevance in the CAP era (1939-59) compared to the prior 12 years (1927-38)
when the median adjusted R2 of the yearly returns regression model is examined.
However, this result is not robust; these differences become insignificant when losses are
excluded from the sample or operating income is used in the yearly regressions in lieu of
.4839 (.5261) as reported in table 4 to .4528 (.4530) when losses are excluded.
31
net income. Other tests based on yearly returns regressions do not yield differences across
periods in explanatory power that differ significantly at conventional levels.
We extend these tests by estimating regressions models which incorporate
summary measures from both the income statement and the balance sheet. Following
Collins, Maydew, and Weiss (CMW) [1997] and Francis and Schipper (FS) [1996], we
estimate yearly cross-sectional regressions where price is the dependent variable and both
earnings and book value are included as independent variables. The results from these
tests are consistent with our returns results in that the incremental relevance of earnings
does not exhibit significant increases following empowerment of the CAP and
reorganizations creating the APB and FASB.
However, in tests examining the time series of the combined relevance of earnings
and book value for equity valuation, we find a significant increase during the tenure of the
FASB (1974-93) compared to that of the APB (1960-73). These findings are consistent
with the evidence in CMW and FS showing an upward trend in combined relevance from
the mid-1950’s through the early 1990’s. For our yearly samples of NYSE stocks, these
results appear attributable to the abnormally low combined relevance of earnings and book
value during the APB’s tenure; when combined relevance during the FASB era is
compared against either the Pre-CAP or CAP eras, differences are not significant at
conventional levels.
Our analysis is based on broad tests of association and, as such, should be
interpreted with caution. Because the nature of our tests does not permit causal
inferences, additional research is necessary to obtain a clearer interpretation of our
findings. We suggest further research in two related areas. First, additional research
32
could examine the impact of specific standards on the relevance of accounting data. Such
analyses could replicate our tests for firms identified as experiencing material financial
statement effects associated with the adoption of new accounting standards. Second,
more research is needed on how other factors influence the valuation relevance of
accounting data. As one example, some have suggested that increased investor utilization
of the balance sheet in recent years is due to increased takeover activity (see Cottle,
Murray, and Block [1988, p. 595]). Additional research could investigate the relative
importance of earnings and book value in valuing the equity of takeover target firms.
33
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Table 1
Results of Hypothesis Tests for Increased Earnings Relevance Across
Alternative Accounting Standard-Setting Regimes Based on Regressions of
16-Month Market-Adjusted Returns on Annual Earnings Changes and Levels
for Yearly NYSE Industrial Samples, 1927-93
Yearly Model: ri = γ0 + γ1 ∆Ei + γ2 Ei + εi
Mean Adj. R2
(t-statistic)3
Median Adj. R2
(z-statistic) 3
A: Comparisons of Mean and Median Adjusted R2
Pre-CAP
CAP
APB
FASB
2
2
2
(1927-38) (1939-59) (1960-73) (1974-93)2
.1879
.2285
.1755
.1453
(0.87)
(-1.55)
(-0.82)
.1570
.2312
.1331
.1393
**
(1.93)
(-1.90)
(0.63)
All Bodies
(1939-93)2
.1847
(-0.08)
.1806
(0.73)
B: Comparison of Adjusted R2 Trends
Time Series Model: ARSQt = δ0 + δ1 τt + δ2 Dt τt + ut 4
Periods Being Compared
δ1 (t-statistic)
δ2 (t-statistic)
Tests of Hypothesis 1
Pre-CAP vs. CAP
.0086
-.0057
Estimation Period: 1927-59
(0.93)
(-0.78)
Pre-CAP vs. CAP-FASB
Estimation Period: 1927-93
-.0007
(-0.11)
-.0006
(-0.10)
Tests of Hypothesis 2
CAP vs. APB
Estimation Period: 1939-73
-.0024
(-0.69)
-.0001
(-0.07)
APB vs. FASB
Estimation Period: 1960-93
-.0020
(-0.44)
-.0000
(-0.02)
1. ri equals the 16-month market adjusted return on security i, ∆Ei equals the change in annual earnings
scaled by beginning of period price for security i, and Ei equals the level of annual earnings scaled by
beginning of period price for security i. The regression model is estimated using cross-sectional data for
yearly samples of NYSE common stocks for each of the 67 years between 1927 and 1993, inclusive.
2. This column shows the mean or median adjusted R2 of the yearly returns regression model estimated
separately for each year in the time period shown in the first column.
3. The test statistics apply to a test of differing mean or median relative to the prior regime for the CAP,
APB, and FASB periods. For the period covered by all bodies, these test statistics apply to a comparison
with the Pre-CAP period.
4. The trend model is estimated for the time period shown in the first column. ARSQt equals the adjusted
R2 of the yearly returns regression model estimated using data from year t, τt equals one in the first year of
the estimation period, two in the second year and so forth, and Dt equals one (zero) during the period
covered by the latter (former) of the two periods being compared, and ut is the residual for year t.
*
Significant at the .05 level for a one-tailed test.
**
Significant at the .01 level for a one-tailed test.
***
Significant at the .001 level for a one-tailed test.
37
Table 2
Results of Empirical Tests Examining the Impact of Losses on Tests
of Increased Earnings Relevance Across Alternative Standard-Setting
Regimes for Yearly Sample of NYSE Firms, 1927-93
A: Incidence and Magnitude of Losses Across
Different Standard-Setting Regimes
Period
Pre-CAP (1927-38)
CAP (1939-59)
APB (1960-73)
FASB (1974-93)
Sample Size
1,171
2,068
1,379
1,973
Mean (Median)
Loss/MVE2
-.405 (-.185)
-.129 (-.085)
-.115 (-.070)
-.235 (-.126)
# (%) Losses1
304 (26.0%)
95 (4.6%)
65 (4.7%)
260 (13.2%)
B: Select Mean and Median Adjusted R2 Levels After Excluding Losses
Yearly Model: ri = γ0 + γ1 ∆Ei + γ2 Ei + εi 3
Mean Adjusted R2
Median Adjusted R2
Losses
Losses
Losses
Losses
4
5
4
Hypothesis 1
Excluded
Included
Excluded
Included5
(1) Pre-CAP (1927-38)
.2004
.1879
.1494
.1570
(2) CAP (1939-59)
.2442
.2285
.2268
.2312
Difference (2) - (1)
.0438
.0406
.0774
.0742
T-Statistic
0.82
0.87
Wilcoxon Z-Statistic
1.22
1.93**
Hypothesis 2
(1) APB (1960-73)
(2) FASB (1974-93)
Difference (2) - (1)
T-Statistic
Wilcoxon Z-Statistic
.2044
.1712
-.0332
-0.69
.1755
.1453
-.0302
-0.82
.1880
.1399
-.0581
.1331
.1393
.0062
-1.00
0.63
1. This column shows the number and percentage of firm-year observations within a given period where
net income is negative.
2. This column shows the mean and median net income scaled by beginning-of-year market value of
equity for all firm-year observations within a given period where net income is negative.
3. ri equals the 16-month market adjusted return on security i, ∆Ei equals the change in annual earnings
scaled by beginning of period price for security i, and Ei equals the level of annual earnings scaled by
beginning of period price for security i. The regression model is estimated using cross-sectional data for
yearly samples of NYSE common stocks for each of the 67 years between 1927 and 1993, inclusive.
4. This column shows the mean and median adjusted R2 of yearly returns regressions for a given time
period estimated using only firm-year observations where net income is positive.
5. This column shows the mean and median adjusted R2 of yearly returns regressions for a given time
period estimated using all firm-year observations. These summary statistics were previously reported in
panel A of table 2.
*
Significant at the .05 level for a one-tailed test.
**
Significant at the .01 level for a one-tailed test.
***
Significant at the .001 level for a one-tailed test.
38
Table 3
Summary Statistics on Adjusted R2 and Coefficient Estimates from
Regressions of Stock Price on Annual Earnings
and Book Value for Yearly NYSE Industrial Samples, 1927-93
Yearly Model: Pi = α0 + α1 Ei + α2 BVi + ui
1
A: Mean and Median Relevance Measures (Across All Years)
Measure
Regression with both E & BV
(Combined Relevance)
Mean
.4408
Median
.4619
Univariate Regression with E
Univariate Regression with BV
.3791
.2454
.3764
.2420
Incremental Relevance of E
Incremental Relevance of BV
.1954
.0333
.1821
.0101
B: Distribution of Yearly Earnings Coefficients
# Years
67
Mean
4.784
Median
4.583
# (%)
Years > 0
67
# (%)
Years > 0
& P<.053
65
C: Distribution of Yearly Book Value Coefficients
# Years
67
Mean
.247
Median
.200
# (%)
Years > 0
59
# (%)
Years > 0
& P<.053
35
1. Pi equals the stock price of security i at the end of the fourth month following month of the fiscal year
end, Ei equals the annual earnings per share of security i, and BVi equals the book value per share of
security i. The regression model is estimated using cross-sectional data for yearly samples of NYSE
common stocks for each of the 67 years between 1927 and 1993, inclusive.
2. The incremental relevance of earnings (book value) for year t equals the adjusted R2 of the yearly price
regression with both earnings and book value included as independent variables less the adjusted R2 of a
univariate regression with only book value (earnings) included as an independent variable.
3. Refers to the frequency of cases that the coefficient is positive and a t-test of the significance of the
coefficient rejects at the .05 level or better using a two-tailed t-test.
39
Table 4
Summary Statistics on the Combined and Incremental Relevance of Earnings and
Book Value Across Alternative Accounting Standard-Setting Regimes Based on
Regressions of Stock Prices on Annual Earnings and Book Value of Equity for
Yearly NYSE Industrial Samples, 1927-93
Yearly Model: Pi = α0 + α1 Ei + α2 BVi + ui 1
Comparisons of Mean and Median Relevance Measures
All
Pre-CAP
CAP
APB
FASB
Bodies
(1927-38)2 (1939-59)2 (1960-73)2 (1974-93)2 (1939-93)2
Incremental
Relevance of E3
Mean
.3169
.1840
.2281
.1115
.1689
(t-statistic)4
(-3.71)
(1.30)
(-4.34)
(-4.78)
Median
.3389
.1909
.2204
.0992
.1588
(z-statistic) 4
(-3.09)
(0.76)
(-3.69)
(-3.88)
Combined
Relevance of
E & BV3
Mean
(t-statistic) 4
Median
(z-statistic) 4
Incremental
Relevance of BV3
Mean
(t-statistic) 4
Median
(z-statistic) 4
.4839
.5261
.0738
.0382
.4549
(-0.68)
.4619
(-0.73)
.3422
(-2.53)
.3009
(-2.27)
.4691
(3.02)***
.4707
(2.22)**
.4314
(-1.30)
.4540
(-1.41)
.0205
(-2.37)
.0150
(-1.40)
.0098
(-1.42)
.0021
(-1.18)
.1338
(3.16)***
.1092
(3.20)***
.0590
(-0.45)
.0185
(-0.70)
1. Pi equals the stock price of security i at the end of the fourth month following month of the fiscal year
end, Ei equals the annual earnings per share of security i, and BVi equals the book value per share of
security i. The regression model is estimated using cross-sectional data for yearly samples of NYSE
common stocks for each of the 67 years between 1927 and 1993, inclusive.
2. This column shows the mean or median relevance measure from the price regression model estimated
separately for each year in the time period shown in the first column.
3. The combined relevance of earnings and book value in year t equals the adjusted R2 from the crosssectional regression of price against earnings and book value per share. The incremental relevance of
earnings (book value) equals the combined relevance measure less the adjusted R2 from a univariate
regression including only book value (earnings) as an independent variable.
4. The test statistics apply to a test of differing mean or median relative to the prior regime for the CAP,
APB, and FASB periods. For the period covered by all bodies, these test statistics apply to a comparison
with the Pre-CAP period.
*
Significant at the .05 level for a one-tailed test.
**
Significant at the .01 level for a one-tailed test.
***
Significant at the .001 level for a one-tailed test.