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Accounting Variables and Stock Returns The Impact of Leverage

Accounting Variables and Stock Returns The Impact of Leverage The fundamental relationship between accounting variables and firm valuation is a recurring theme in capital market research. This paper investigates this relationship within a balance sheet context and highlights the importance of controlling for relevant economic factors. We do this by conditioning explanatory power on the firm's relative financial leverage position, after controlling for cashflows and firm size, and using an arctan regression model to take account of temporary components in cash and earnings flows. Using data for 743 firmyears for Australian Stock Exchange listed stocks, we find that for firms which are above optimal leverage i earnings contain a greater level of transitory items, particularly when firm size is small and ii cashflows provide higher incremental information. Our results are consistent with investors perceiving earnings as progressively less informative as the probability of failure increases, and the likelihood of earnings manipulation for the purpose of reducing proximity to debt covenants increases. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Pacific Accounting Review Emerald Publishing

Accounting Variables and Stock Returns The Impact of Leverage

Pacific Accounting Review , Volume 12 (2): 28 – Feb 1, 2000

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
0114-0582
DOI
10.1108/eb037952
Publisher site
See Article on Publisher Site

Abstract

The fundamental relationship between accounting variables and firm valuation is a recurring theme in capital market research. This paper investigates this relationship within a balance sheet context and highlights the importance of controlling for relevant economic factors. We do this by conditioning explanatory power on the firm's relative financial leverage position, after controlling for cashflows and firm size, and using an arctan regression model to take account of temporary components in cash and earnings flows. Using data for 743 firmyears for Australian Stock Exchange listed stocks, we find that for firms which are above optimal leverage i earnings contain a greater level of transitory items, particularly when firm size is small and ii cashflows provide higher incremental information. Our results are consistent with investors perceiving earnings as progressively less informative as the probability of failure increases, and the likelihood of earnings manipulation for the purpose of reducing proximity to debt covenants increases.

Journal

Pacific Accounting ReviewEmerald Publishing

Published: Feb 1, 2000

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