Faculty Scholarship 1994 - Present
Effects of Book Value on Equity Valuation; The Case of Taiwanese Firms
This study investigates the effects of earnings and book value on equity valuation for firms listed in the Taiwan Stock Exchange. Previously many empirical accounting studies documented the association between earnings and equity value. This line of research can be traced back to Ball and Brown (1968) who found a positive association between the sign of abnormal price returns and the sign of unexpected earnings. Prior studies also showed a positive association between the magnitude of abnormal price returns and the magnitude of abnormal earnings (e.g., Beaver, Clark and Wright, 1979), and found value relevance of the components of earnings (e.g., Bowen, 1981; Daley, 1984; Fairfield, Sweeney and Yohn, 1996). Book value, on the other hand, has been deemed somewhat meaningless in equity valuation because the balance sheet, prepared based on the historical cost assumption, usually does not reflect a firm's current market value (Brownlee, Ferris and Haskins, 1990). Recently, however, there is a serious challenge regarding the usefulness of book value in equity valuation. For example, Ohlson (1995) derived a valuation model that is a linear additive function of both earnings and book value. Burgstahler and Dichev (1997) derived another valuation model that is a piece-wise function of both earnings and book value. Bernard (1993) found that book value per share explains 55 percent of the cross-sectional variance in stock price. The objective of this study is to investigate the impacts of both earnings and book value on the valuation of stocks traded in the Taiwan Stock Exchange. In particular, three main hypotheses are tested in this paper. First, both earnings and book value--not just earnings, are value relevant in the firm valuation process; and each one is a major determinant of firm values. Second, the relative importance of earnings and book value depends on the types of firms studied(the shifting relative-importance hypothesis): the more successful a firm is, the more important of its earnings is as the dominant factor in firm valuation; and the less successful a firm is, the more useful its book value is in firm value etermination. Finally, firms reporting losses have different pricing effects on firm values from those of firms reporting earnings.