Specification of the Market-Accounting Relation

Abstract

We argue that log-linear models, using elasticities to measure response coefficients in regression models of the market-accounting relation, are well specified and provide precise, readily interpreted and valid estimates of the relation between market and accounting values. Using this approach we show that fundamental financial statement data is sufficient, with little or no extra data, to explain firm market value. We illustrate the approach by discussing the evidence for dividend irrelevancy, the relationship of the market to book ratio with growth and its uncertainty, and the existence of abandonment options. Our method of estimating parameters in the market-accounting relation facilitates replication. We use all active Compustat firms between 1971-2020, without deletion or treatment of outliers. Our results demonstrate the utility of using log-linear models for capital market research in accounting.