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Scale and the Scale Effect in Market‐based Accounting Research

Scale and the Scale Effect in Market‐based Accounting Research The nature of the data we usually encounter in market‐based accounting research is such that the results of the regressions of market capitalization on financial statement variables (referred to ‘price‐levels’ regressions) are driven by a relatively small subset of the very largest firms in the sample. We refer to this overwhelming influence of the largest firms as the ‘scale effect’. This effect is more than heteroscedasticity. It arises due to the non‐linearity in the relation between market capitalization and the financial statement variables. We present the case that scale is market capitalization rather than a correlated omitted variable. Since scale is market capitalization, we advocate its use as a deflator in a regression estimated using weighted least squares. This regression overcomes the scale effect and the resultant regression residuals are more economically meaningful. Christie's (1987) depiction of scale is the same as ours but he advocates the use of the returns regression specification in order to avoid scale effects. We agree that returns regressions should be used unless the research question calls for a price‐levels regression. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Business Finance & Accounting Wiley

Scale and the Scale Effect in Market‐based Accounting Research

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References (32)

Publisher
Wiley
Copyright
Copyright © 2003 Wiley Subscription Services, Inc., A Wiley Company
ISSN
0306-686X
eISSN
1468-5957
DOI
10.1111/1468-5957.00482
Publisher site
See Article on Publisher Site

Abstract

The nature of the data we usually encounter in market‐based accounting research is such that the results of the regressions of market capitalization on financial statement variables (referred to ‘price‐levels’ regressions) are driven by a relatively small subset of the very largest firms in the sample. We refer to this overwhelming influence of the largest firms as the ‘scale effect’. This effect is more than heteroscedasticity. It arises due to the non‐linearity in the relation between market capitalization and the financial statement variables. We present the case that scale is market capitalization rather than a correlated omitted variable. Since scale is market capitalization, we advocate its use as a deflator in a regression estimated using weighted least squares. This regression overcomes the scale effect and the resultant regression residuals are more economically meaningful. Christie's (1987) depiction of scale is the same as ours but he advocates the use of the returns regression specification in order to avoid scale effects. We agree that returns regressions should be used unless the research question calls for a price‐levels regression.

Journal

Journal of Business Finance & AccountingWiley

Published: Jan 1, 2003

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