Accounting conservatism, firm growth, earnings persistence, and earnings-based valuation

This paper examines how accounting conservatism, firm growth, and earnings persistence are related to the estimation of firm value from the Ohlson (1995) earnings-based valuation framework. The study tests the associations between the three aforementioned factors and both model-based valuation errors and a measure which stems from the Ohlson (1995) framework and represents the perpetual growth in cum-dividend abnormal earnings. The valuation errors are the difference between firm stock price (which is used as a proxy for firm intrinsic value) and estimated firm value from an Ohlson (1995) valuation model within the framework. Signed valuation errors are used in the tests. The proxy for the perpetual growth in cum-dividend abnormal earnings is calculated three different ways. First, it is computed as a finite time period cum-dividend growth in abnormal earnings. Also, it is imputed two different ways using one of the models from the Ohlson (1995) framework. The proxies for accounting conservatism, firm growth, and earnings persistence are derived using measures from the financial statements or parameters from a linear information model developed by Feltham and Ohlson (1995). The results show that accounting conservatism, firm growth, and earnings persistence cause the Ohlson (1995) earnings-based valuation framework to underestimate firm value relative to stock price. Also, the results show that accounting conservatism and firm growth are positively related to the proxy for the perpetual growth in cum-dividend abnormal earnings.