Which Performance Measure Do Investors Use

THE ACCOUNTING REVIEW Vol. 85, No. 3 2010 pp.
753789
American Accounting Association DOI: 10.2308/accr.2010.85.3.753
Which Performance Measures Do Investors Around the World Value the Mostand Why?
Jan Barton Emory University Thomas Bowe Hansen University of New Hampshire Grace Pownall Emory University
ABSTRACT: We examine the value relevance of a comprehensive set of summary performance measures including sales, earnings, comprehensive income, and operating cash ows. We nd that, while value relevance peaks for measures above the line, no single measure dominates around the world. Instead, a measure is more relevant when it captures, directly and quickly, information about rms cash ows. Specically, for each performance measure by country, we estimate eight attributes commonly used to assess earnings quality. We nd these attributes highly correlatedmost of their variance is explained by only two principal factors. A factor capturing articulation with cash ows is positively associated with a measures value relevance; a factor reecting the measures persistence, predictability, smoothness, and conservatism is negatively associated. Our results suggest that, when it comes to equity valuation, accounting researchers and standard-setters should focus not on what performance measure is best at a given point in time, but on the underlying attributes that investors nd most relevant. Keywords: summary performance measure; earnings attributes; value relevance; international accounting standard setting. Data Availability: Data are available from sources identied in the paper.
We appreciate the helpful comments of Steve Kachelmeier senior editor , an anonymous reviewer, Linda Bamber, Mary Barth, Phil Berger, Andy Call, Jenny Gaver, Stacie Laplante, Katherine Schipper, Matt Wieland, workshop participants at The University of Georgia, and participants in the Reporting Financial Performance workshops in Bordeaux, New York, Washington D.C., and Istanbul. We also thank Ron Harris for research assistance, and the Goizueta Business School, the IAAER Reporting Financial Performance Research Program, and the KPMG Foundation for generous funding. Editors note: Accepted by Steven Kachelmeier.
Submitted: February 2008 Accepted: August 2009 Published Online: May 2010 753
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I. INTRODUCTION ecent research suggests that revenue exhibits value relevance that differs from that of various expenses and other line items making up earnings on the income statement, perhaps due to the differential persistence, heterogeneity, and ease with which those line items can be misreported. Some studies e.g., Ertimur et al. 2003 nd that revenues are more value relevant than earnings in at least some circumstances. Chandra and Ro 2008 extend the comparison of both information content and value relevance between revenues and a performance measure that includes expenses, gains, and losses, nding that the incremental value relevance of revenues is pervasive rather than conned only to cases in which earnings are less informative. Taken together, these ndings raise validity concerns regarding the assumption underpinning the literature that earnings is the most relevant performance measure for equity valuation. Consistent with these concerns, in a study of the valuation implications of losses, Hayn 1995, 150 suggests the need for examining the degree of substitution between earnings numbers and alternative accounting variables. We expand the comparison of the value relevance of line items, subtotals, and totals on the statements of nancial performance to support broad generalizations about the usefulness of performance measures and the reasons for the increased usefulness of some measures relative to others. Our goal is to provide insight to standard-setters for the project on reporting nancial performance currently being pursued by the Financial Accounting Standards Board FASB and the International Accounting Standards Board IASB .1 The joint FASB/IASB project on reporting nancial performance proposes to explore whether certain line items, subtotals, and totals should be dened in standards and required to be displayed in nancial statements FASB 2001, 5 and to consider whether to require the display of summarized amounts such as operating income or income from core activities, EBITDA, or operating cash ow FASB 2001, 2 . We estimate and compare the value relevance of a comprehensive set of performance measures commonly disclosed in the nancial statements of almost 20,000 rms from 46 countries during 19962005. Our performance measures are operating cash ows, sales, EBITDA, operating income, income before taxes, income before extraordinary items and discontinued operations, net income, and total comprehensive income. We nd that the value relevance of the performance measures varies substantially across line items on the income statement as well as across countries. In general, subtotals near the center of the income statement, such as operating income, have the strongest association with contemporaneous stock returns; subtotals at the top or bottom of the income statement, such as sales and total comprehensive income, have the weakest association with stock returns. Although the weak association between sales and stock returns is fairly robust across countries, we observe weak value relevance of net income and total comprehensive income mostly in common-law countries. We also estimate seven attributes of each performance measure that are assumed in the literature to increase the value relevance of earnings. We draw our estimation methods for these seven earnings attributespersistence, predictability, smoothness, contemporaneous and lagged association with operating cash ows, timeliness, and conservatismfrom the literatures on the properties of earnings and earnings quality, and consider whether these attributes reect unique underlying constructs. We nd that estimates of the seven attributes are strongly correlated with each other, making interpretation of the attributes and a regression of value relevance on these attributes problematic. We then perform a principal components factor analysis to address the collinearity among these attributes, thereby reducing the dimensionality of the data and developing
Barth, Beaver, and Landsman 2001 and Holthausen and Watts 2001 provide an insightful academic debate on the role of the value relevance literature in nancial reporting standard-setting.
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a parsimonious description of the underlying constructs. We nd that two intuitively appealing factorscorresponding to the notions of sustainability and articulation with cash owsexplain about 80 percent of the variance of the seven attributes. Each of these two factors is signicantly correlated with our proxy for value relevance: the articulation-with-cash-ows factor positively, and the sustainability factor negatively. We interpret these ndings as suggesting that performance measures that reect more closely and timely changes in current and expected future operating cash ows are more useful to equity investors. On the other hand, performance measures that are more persistent, predictable, smooth, and conservative are less useful for equity valuation. Taken together, our evidence indicates that optimal performance measures useful in equity valuation vary across different economic circumstances and accounting regimes as a function of the underlying attributes of the performance measures. Therefore, researchers and standard-setters should focus not on what performance measure is best at any one point in time, but rather should focus on the underlying attributes demanded by nancial statement users. We contribute to the academic literature in three specic ways. First, we extend the literature comparing the information content and value relevance of performance measures other than earnings. One performance measure will convey more or less information relative to another if the two are not perfectly correlated, that is, when the information they contain about future earnings or cash ows is different. Ertimur et al. 2003 and Jegadeesh and Livnat 2006 nd that stock prices respond to both revenue and earnings information contained in announcements. Chandra and Ro 2008 examine the incremental value relevance and information content of revenue given earnings to determine whether the superiority of revenue is pervasive or just conned to cases in which earnings is less informative. Such cases include extreme earnings events, as well as settings for which the accounting model is not well-specied see Lev and Zarowin 1999 for technology rms, and Davis 2002 and Hayn 1995 for periods of economic shocks or losses . Chandra and Ro 2008 nd that the incremental value relevance of revenues is pervasive and increasing over time. They argue that revenues contain information about future earnings and cash ows that is lost when revenues are aggregated with nonoperating items, gains, losses, unusual and infrequent items, and other events and transactions with different persistence, stickiness, and exibility for earnings management. We extend this literature by examining a comprehensive set of nancial performance measures, explicitly considering a broader set of attributes of performance measures that may lead to differential value relevance, and expanding the capital market context beyond the U.S. setting by including rms traded in the global capital market. Second, we extend the literature comparing attributes and pricing effects of earnings, accruals, cash ows, pro forma or core earnings, and nonnancial performance measures. For example, Vincent 1999 compares the relative and incremental information content of funds from operations and earnings per share for real estate investment trusts. Francis et al. 2003 investigate the ability of earnings and a variety of non-earnings performance measures identied at the industry level to explain stock returns. Finally, Bradshaw and Sloan 2002 document the increased use of pro forma earnings in the last two decades of the twentieth century, comparing the relative association with stock returns of GAAP earnings and pro forma earnings. We add to this literature by investigating why particular performance measures are useful, in addition to documenting which performance measures are most useful in the global capital market and within each particular accounting regime. This analysis builds on the evidence presented by Francis et al. 2004 , who investigate the relationship between the cost of capital and seven earnings attributes. We expand their ndings by using similar attributes to investigate the relationship between the infor-
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mation content of performance measures and their underlying attributes.2 Our evidence indicates that performance measures that are optimal for equity valuation vary across different economic and accounting regimes as a function of the underlying attributes of the performance measures. Finally, we contribute to the substantial body of research on the properties of earnings and its components, both in the United States and globally e.g., Lipe 1986; Rayburn 1986; Alford et al. 1993; Ball et al. 2000; Barth, Cram, and Nelson 2001; Barth et al. 2002; Leuz et al. 2003 . Much of this literature treats each attribute as independent, either by including only one or two attributes in the empirical tests, or by including several attributes as independent variables in regression analyses. For example, Lipe 1990 examines the impact of the persistence of earnings and the ability of current earnings to predict future earnings on a rms earnings response coefcient. In contrast, Francis et al. 2004 examine the association between the cost of capital and seven earnings attributes. However, empirical evidence indicates that earnings attributes are often strongly correlatedChaney et al. 2008 nd that a principal component analysis of earnings quality measured as in Dechow and Dichev 2002 , persistence, predictive ability, and smoothness results in only one factor with an eigenvalue greater than 1.3 Our evidence indicates that researchers should consider the potential relationships among performance attributes when using them to test accounting theories.4 Section II discusses our performance measure attributes and their relationship with the measures value relevance. We describe our sample and data in Section III; Section IV presents analyses regarding our value relevance measures and the attributes of our performance measures. In Section V, we use a principal components factor analysis to examine the correlation structure among the performance measure attributes, and we investigate the relationship between these attributes factors intuitively corresponding to sustainability and articulation with cash ows and the measures value relevance. Section VI offers concluding remarks. II. PERFORMANCE MEASURE ATTRIBUTES AND VALUE RELEVANCE In this section, we describe the seven performance measure attributes that we consider in our analyses and explain why the presence or absence of each attribute would affect a performance measures value relevance. We focus on a measures value relevanceits ability to explain variation in contemporaneous stock returnsbecause value relevance is generally viewed in the literature as a direct estimate of the measures usefulness in equity investors decision making e.g., Collins et al. 1997; Francis and Schipper 1999; Lev and Zarowin 1999 . Moreover, the FASB considers relevance as a primary quality that makes accounting information useful to investors FASB 1980; Barth, Beaver, and Landsman 2001; Holthausen and Watts 2001 .
3 4
Our attributes differ from those in Francis et al. 2004 in two ways. First, we use value relevance as our dependent variable rather than as an explanatory variable because our research question focuses on which performance measure is useful to investors. In addition, their dependent variable is cost of capital, measured using Value Line reports, a data requirement that is unavailable for the majority of our sample rms. Second, they include quality measured as in Dechow and Dichev 2002 as an earnings attribute. However, this attribute is theoretically designed to measure the quality of a particular performance measurenet income. As an analog to this measure, we include two attributes: the ability of a performance measure to predict next periods cash ows, and the closeness of a performance measure to current period cash ows. They retain a second factor in their analysis with an eigenvalue of 0.95, indicating that the majority of the variation in these four attributes can be explained by essentially two factors. This result represents an empirical observation rather than a theoretical relationship between the attributes. For example, the strength of the association between persistence and predictability is determined by the magnitude of the error term in the rst-order autoregressive model commonly used to measure these variables. A rm may have very persistent earnings that are relatively unpredictable if the mean shock is large, or nonpersistent earnings that are quite predictable if the mean shock is small. See Lipe 1990 for a description of the conceptual difference between these variables, and Schipper and Vincent 2003 for a description of the relationships among a wide variety of earnings attributes.
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Consistent with Francis et al. 2004 , we argue that, to the extent that a particular attribute captures some aspect of the uncertainty about future cash ows available to equity holders, a favorable outcome of that attribute for a particular performance measure will make that measure more value relevant. We select our attributes based on their use in prior academic literature. In particular, we are consistent with recent literature by considering the same or analogous attributes as those examined by Francis et al. 2004 . We describe in turn each of the attributes we consider and provide intuition regarding each attributes relationship with value relevance. Persistence This construct captures in part the performance measures sustainability over time. We follow Lev 1983 , Ali and Zarowin 1992 , and Francis et al. 2004 in measuring performance measure js PERSISTENCE in country k as the slope coefcient 1 in the rst-order autoregressive model: Performance Measure j
it+1,k
0,k
1,k
Performance Measure j
it,k
it,k .
Values of 1 close to 1 indicate highly persistent performance, while values close to 0 indicate highly transitory performance. If 1 = 1, then the performance measure follows a random walk, 1, the performance measure is expected to converge to a long-term mean with drift 0. If 1 of 0 / 1 1 , with 1 capturing the speed of convergence. As usual, the subscripts i and t denote rm and year, respectively. Investors are more likely to view more persistent measures as desirable since those measures are recurring e.g., Penman and Zhang 2002; Revsine et al. 2002, 245; Richardson 2003 . Consistent with this view, Lipe 1986 shows that the information content of earnings components is increasing in the components persistence. Similarly, Bhattacharya et al. 2003 and Brown and Sivakumar 2003 show that core earnings, which tends to be more persistent than net income, is more value relevant than net income. Therefore, we expect more persistent performance measures to be more value relevant. Predictability A measures predictabilityits ability to predict itselfis not only valued in security analysis and equity valuation see, e.g., AIMR 1993; Lee 1999 , but it is also an element of relevance in the FASBs conceptual framework and, hence, a desirable attribute from the perspective of standardsetters FASB 1980 . However, Francis et al. 2004 argue that the link between predictability and information content is unclear. For example, highly predictable earnings may indeed eliminate uncertainty about future earnings. But if managers make opportunistic accounting choices to increase the predictability of earnings, then such persistence might in fact lead to earnings numbers that are less value relevant, especially if managers accounting choices reduce the ability of earnings to convey information about future cash ows to shareholders. Therefore, we make no directional prediction regarding the relationship between PREDICTABILITY and value relevance. Our proxy for a performance measures PREDICTABILITY is the adjusted R2 for the rstorder autoregressive model shown in Equation 1 , similar in spirit to the square root of the regressions error variance used by Lipe 1990 and Francis et al. 2004 . Larger values of PREDICTABILITY imply more predictable performance. Smoothness Ronen and Sadan 1981 , Chaney and Lewis 1995 , Demski 1998 , and many others argue that smoothness is a desirable earnings attribute if managers use their private information about future earnings to smooth out transitory uctuations. Such smoothing behavior would lead to more representative and useful reported earnings. However, if the smoothness of performance measures
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results from earnings management, as assumed by for example Leuz et al. 2003 , then smoothness indicates that managers have added noise to the performance measure, thus reducing its value relevance Ohlson and Penman 1992 . We are therefore unable to make a prediction regarding the association between SMOOTHNESS and value relevance. Our proxy for performance measure js SMOOTHNESS is the slope coefcient 1 from a regression of the standard deviation of the measure on the standard deviation of operating cash ows sdOCF , with both standard deviations measured over the sample period: sd Performance Measure j
it,k
1,ksdOCFit,k
it,k .
We constrain the regression to have no intercept, such that the regressions slope is equivalent to the smoothness measures used in previous work e.g., Francis et al. 2003; Leuz et al. 2003 . Smaller values of SMOOTHNESS indicate a smoother performance measure relative to operating cash ows, with the latter dened as SMOOTHNESS 1. Predictability of Future Cash Flows Investors tend to view performance measures that are more useful in predicting future cash ows as being more desirable FASB 2002 . Therefore, we expect performance measures with a greater ability to predict future cash ows to be more value relevant. We estimate performance measure js ability to predict one-period-ahead cash ows, PREDICT_OCF, as the adjusted R2 from the regression: OCFit+1,k =
0,k
1,k
it,k
it,k ,
where OCF is the rms operating cash ows. Substitute for Cash Flows Some practitioners and academics take the position that earnings mapping more closely to operating cash ows is of higher quality Harris et al. 2000; Dechow and Dichev 2002; Penman 2007 . The underlying assumption is that if a performance measure is closer to the rms cash ows, then accrual accountingand therefore managers judgments and estimateswill have less of an effect on the reported performance measure. For instance, the less discretion managers exercise over the accrual process, the fewer opportunities they have to introduce noise into the performance measure. Therefore, we expect measures that are closer to operating cash ows to have greater value relevance.5 We measure each performance measures ability to substitute for operating cash ows, SUBST_OCF, as the slope coefcient 1 in the regression: OCFit,k =
0,k
1,k
it,k
it,k ,
where OCF is the rms operating cash ows. Conservatism Conservatism reects the differential ability of accounting earnings to capture economic losses versus economic gains Basu 1997; Ball et al. 2000; Watts 2003 . Managers have incentives to disclose good news quickly and to delay the disclosure of bad news McNichols 1988 . However, nancial statement users likely view disclosures that are inconsistent with managers incentives as being more credible Mercer 2004 . Therefore, conservative accounting is likely viewed as more credible. Consistent with this view, LaFond and Watts 2007 argue that conservative nan5
An alternative argument is that accrual accounting reduces the noise resulting from lumpy cash ows, removing the ability of managers to manipulate earnings by timing cash inows and outows. This interpretation would lead to the inference that performance measures that are closer to cash ows are less value relevant.
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cial statements serve an informational role by reducing managers incentives and ability to manipulate accounting numbers, thus reducing information asymmetry between managers and shareholders. However, Francis et al. 2004 argue that conservatism, by denition, implies biased information and, hence, does not necessarily improve the quality of accounting performance measures. Therefore, we make no directional prediction regarding the relationship between conservatism and value relevance. Following Ball and Shivakumar 2005 , we measure conservatism relative to operating cash ows as the asymmetric timeliness coefcient 3,k from the regression of performance measure j on proxies for good news i.e., positive cash ows and bad news i.e., negative cash ows :6 Performance Measure j
it,k
0,k
1,kNEGit,k
2,kOCFit,k
3,kNEGit,k
OCFit,k +
it,k .
5 The indicator NEG is coded 1 if OCF 0, and 0 otherwise. The coefcient is standardized i.e., multiplied by the standard deviation of the interaction NEGit,k OCFit,k, then divided by the standard deviation of the performance measure j in country k . We set CONSERVATISM to 0 for performance measure OCF. Larger values of CONSERVATISM indicate performance measures that capture changes in the rms economic performance sooner relative to cash ows. Timeliness Timeliness captures a performance measures ability to reect quickly both good and bad news about the rms performance. As a performance measure attribute, it assumes that accounting numbers are intended to measure changes in the rms economic position Ball et al. 2000 . Timely information is considered not only more relevant in decision making, but also more reliable. With respect to earnings, for example, Francis et al. 2004 argue that timeliness increases the reliability of the information reported. Because the FASB considers relevance and reliability as the two primary attributes that make accounting information useful to investors FASB 1980 , timeliness is likely a desirable attribute from the standard-setters point of view. Our measure of TIMELINESS is the estimated adjusted R2 for Equation 5 . This interpretation is based on the role of accruals in capturing information regarding future cash ows as well as the positive correlation between current cash ows and future expected cash ows Ball and Shivakumar 2005 . We set TIMELINESS to 1 in the case of performance measure OCF. Larger values of TIMELINESS indicate performance measures that capture changes in the rms economic performance in a more timely fashion. III. SAMPLE We begin constructing our sample with the 206,730 rm-years available during 19962005 for the 26,479 rms in the Compustat Global Vantage database. The largest number of observations come from Japan 38,731 rm-years and the United States 37,330 rm-years . Table 1 presents the subsequent restrictions that we impose on the sample. We present data on the observations aggregated by country because country groups are arguably the most homogeneous subunits of the data. Value relevance may vary between line items, subtotals, and totals on the statements of nancial performance across countries due to economic fundamentals such as the
6
Conservatism and timeliness are typically measured in the literature following Basu 1997 , with stock returns instead of operating cash ows in the right-hand side of Equation 5 . Ball and Shivakumar 2005 adapt Basus 1997 model to private rms by measuring conservatism and timeliness relative to operating cash ows. We follow their approach to avoid inducing a mechanical correlation between the value relevance and the conservatism/timeliness attributes of the performance measures we examine. As we report later in Section IV, using returns-based rather than cash-ow-based measures of conservatism and timeliness yields similar conclusions.
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TABLE 1 Sample Selection

Initial Sample FirmYears 9,769 6,368 18,626 37,330 7,429 7,760 38,731 340 1,088 7 20 10 1,443 9 4,423 5 1,413 26 1,733 1,065 12,210 259 36 38 229 1,909 Missing Market Data 3,836 1,097 3,223 5,073 1,470 1,720 6,198 38 149 4 7 7 264 3 1,070 2 242 6 645 136 9,450 58 9 1 31 486 Less Deleted Firm-Years Missing Accounting Data 1,437 751 5,112 3,992 1,482 1,419 2,053 82 307 0 10 0 450 1 673 1 314 5 232 203 169 81 11 22 76 475 Inadequate Subsample 0 0 0 0 0 0 0 0 0 3 3 3 0 5 2,680 2 0 15 856 0 0 0 16 15 0 0 Extreme Values 303 285 686 1,804 326 365 2,582 13 34 0 0 0 52 0 0 0 44 0 0 54 176 7 0 0 6 67 Final Sample FirmYears 4,193 4,235 9,605 26,461 4,151 4,256 27,898 207 598 0 0 0 677 0 0 0 813 0 0 672 2,415 113 0 0 116 881
Country Australia Canada U.K. U.S.A. France Germany Japan Argentina Austria Bahamas Bahrain Bangladesh Belgium Belize Bermuda Botswana Brazil Virgin Islands Cayman Islands Chile China Colombia Croatia Cyprus Czech Rep Denmark
Firms 1,553 822 2,787 4,685 1,013 985 4,269 40 145 1 2 1 195 1 548 1 177 4 317 125 1,450 34 4 4 33 247
Firms 1,106 696 1,863 3,973 742 761 3,795 30 104 0 0 0 118 0 0 0 146 0 0 102 921 19 0 0 24 155
(continued on next page)
TABLE 1 (continued)
Initial Sample FirmYears 126 24 1,231 10 9 3 853 7 10 2,110 193 40 2,688 2,485 753 605 2,815 35 10 2,239 20 11 18 30 18 305 7,546 Missing Market Data 27 3 333 0 1 3 103 3 10 174 16 23 202 310 142 76 614 0 0 321 14 5 6 10 7 88 1,272 Less Deleted Firm-Years Missing Accounting Data 71 12 185 3 7 0 206 4 0 877 31 10 580 594 163 215 761 26 4 488 1 6 1 20 3 106 1,360 Inadequate Subsample 28 9 0 7 1 0 0 0 0 0 0 7 0 0 0 0 0 9 6 0 5 0 11 0 8 0 0 Extreme Values 0 0 55 0 0 0 44 0 0 88 5 0 153 126 30 16 106 0 0 120 0 0 0 0 0 8 390 Final Sample FirmYears 0 0 758 0 0 0 500 0 0 971 141 0 1,753 1,455 418 298 1,334 0 0 1,310 0 0 0 0 0 103 4,524
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Country Egypt Estonia Finland Gabonese Republic Ghana Gibraltar Greece Greenland Guyana Hong Kong Hungary Iceland India Indonesia Ireland Israel Italy Jordan Kenya Korea Kuwait Latvia Liberia Liechtenstein Lithuania Luxembourg Malaysia
Firms 15 3 156 1 1 1 112 1 1 252 24 6 321 308 103 73 391 4 1 315 2 2 2 3 3 41 910
Firms 0 0 129 0 0 0 85 0 0 143 22 0 290 243 76 48 241 0 0 256 0 0 0 0 0 19 764
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TABLE 1 (continued)
Initial Sample FirmYears 29 10 8 838 22 63 2 50 2,279 970 1,685 516 28 40 246 1,654 436 543 4 28 183 45 3,959 70 64 2,235 1,619 Missing Market Data 0 0 2 140 4 5 0 1 387 245 506 34 1 2 36 128 44 64 0 5 20 15 778 4 16 292 275 Less Deleted Firm-Years Missing Accounting Data 29 0 0 173 7 34 1 29 498 224 269 194 6 2 60 610 159 133 4 12 38 26 516 33 8 840 320 Inadequate Subsample 0 10 6 0 11 24 1 20 0 0 0 0 21 36 0 0 0 0 0 11 0 4 0 33 40 0 0 Extreme Values 0 0 0 42 0 0 0 0 91 49 62 19 0 0 6 64 13 28 0 0 8 0 216 0 0 70 67 Final Sample FirmYears 0 0 0 483 0 0 0 0 1,303 452 848 269 0 0 144 852 220 318 0 0 117 0 2,449 0 0 1,123 957
762
Country Malta Marshall Islands Mauritius Mexico Monaco Morocco Namibia Neth. Antilles The Netherlands New Zealand Norway Pakistan Panama Papua New Guinea Peru Philippines Poland Portugal Qatar Romania Russia Saudi Arabia Singapore Slovakia Slovenia South Africa Spain
Firms 3 1 1 113 3 8 1 5 296 144 241 59 3 5 27 196 55 76 2 4 22 9 546 9 8 329 209
Firms 0 0 0 79 0 0 0 0 211 99 166 48 0 0 20 131 41 59 0 0 20 0 470 0 0 226 154
TABLE 1 (continued)
Initial Sample FirmYears 57 2,988 2,640 2,575 3,527 532 5 31 124 10 55 206,730 Missing Market Data 0 858 433 393 304 24 5 10 11 5 17 44,538 Less Deleted Firm-Years Missing Accounting Data 30 397 707 460 809 204 0 13 52 1 15 32,005 Inadequate Subsample 27 0 0 0 0 0 0 8 61 4 23 4,029 Extreme Values 0 144 101 131 189 25 0 0 0 0 0 9,270 Final Sample FirmYears 0 1,589 1,399 1,591 2,225 279 0 0 0 0 0 117,474
Country Sri Lanka Sweden Switzerland Taiwan Thailand Turkey Ukraine United Arab Emirates Venezuela Zambia Zimbabwe Total
Firms 7 401 317 342 448 62 1 6 16 1 8 26,479
Firms 0 310 208 288 336 47 0 0 0 0 0 19,784
The nal sample consists of 117,474 observations for 19,784 public rms over 19962005 with data available on Compustats Global Vantage. The sample excludes 44,538 observations without data to calculate stock returns; 32,005 observations without accounting data to calculate the performance measures; 4,029 observations from countries with fewer than 100 rm-years during the sample period, from Bermuda and from the Cayman Islands; and 9,270 observations in the extreme 1st and 99th percentiles of the distributions of the performance measures.
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incidence of losses or industry composition, accounting standards, enforcement mechanisms, and capital market incentives Ali and Hwang 2000; Ball et al. 2000; Ashbaugh-Skaife et al. 2006; Boonlert-U-Thai et al. 2006; La Porta et al. 2006; Jackson and Roe 2009 . To reduce the burden of interpreting the data disaggregated into 46 subunits, we arrange the tables whenever possible so that the rst seven rows of each panel describe the seven equity capital markets most frequently studied in cross-national research of the properties of accounting numbers. These seven markets together constitute about 66 percent of the global market for equity securities as of April 2008 World Federation of Exchanges 2008 ; these seven markets and their percentage of the global equity market are Australia 2.1 percent , Canada 6.3 , United Kingdom 6.3 , United States 32.6 , France/Euronext 7.0 , Germany 3.5 , and Japan 8.1 . The rst four of these are in common-law countries and the nal three are in code-law countries.7 The remaining rows in Table 1 and in all subsequent tables describing country-level data present statistics for all other countries in the sample. Table 1 shows that we lose 44,538 rm-years 21.5 percent of the sample because of missing stock return data. We also lose 32,005 rm-years 15.5 percent due to missing accounting data, primarily EBITDA and sales. We exclude 4,029 rm-year observations 1.9 percent from two countries with fewer than 100 rm-yearsBermuda and the Cayman Islands. Finally, we drop 9,270 rm-years 4.5 percent in the extreme 1 percentiles of the distribution of scal-year stock return, sales, EBITDA, operating income, income before taxes, income before extraordinary items and discontinued operations, net income, total comprehensive income, and operating cash ows. The nal sample consists of 117,474 rm-years representing 19,784 rms. The nal distribution of rm-years across countries is consistent with that of the original sample, with the largest numbers of observations still from Japan 27,898 and the United States 26,461 . Table 2 presents descriptive statistics for our sample. Panel A shows that the number of rms covered by Global Vantage in the United States and Canada peaked in the late 1990s and has been decreasing in the current decade. A less pronounced pattern, peaking early in this decade, is apparent in the number of German and French companies covered. The decrease in Global Vantage coverage in these North American and European economies is similar to decreases in the number of companies listed in each of these jurisdictions during our sample period see also Smith and Cohen 2007 . Coverage of companies in most other countries is fairly stable across time, with the exception of extensive growth in Australia, China, Korea, Singapore, and Taiwan. Table 2, Panel B shows that the observations from both common- and code-law countries cover a wide range of industries. The largest number of rms in most countries is in the manufacturing sector SIC codes 2039 . However, industry representation varies across countries, with the mining and construction industries particularly well-represented in Australia and Canada, and the utilities and communications industries each representing the largest percentage of observations in at least one country. Finally, Panel C shows median values for a selection of rm characteristics. The sample exhibits a great deal of variation across countries in terms of the median rms size, accounting performance, equity market performance, leverage, and percentage of loss years. The tenor of the results we report later is largely invariant to these industry and scale differences.
See Ali and Hwang 2000 and La Porta et al. 2006 for a discussion of code- and common-law countries.
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TABLE 2 Sample Description

Panel A: Distribution of Firms by Year Country 1996 1997 Australia Canada U.K. U.S.A. France Germany Japan Argentina Austria Belgium Brazil Chile China Colombia Czech Republic Denmark Finland Greece Hong Kong Hungary India Indonesia Ireland Israel Italy Korea Luxembourg Malaysia 194 438 752 2,859 261 258 2,544 12 40 45 10 16 2 5 0 58 33 9 62 0 92 65 30 14 60 17 2 198 211 438 959 2,923 361 317 2,634 18 65 56 34 17 60 7 7 80 59 21 75 10 118 94 37 24 102 17 5 314 1998 226 444 1,029 2,908 357 332 2,615 21 69 55 77 78 97 14 21 91 59 38 98 18 209 145 46 31 112 62 6 400 1999 263 429 950 2,730 372 382 2,645 24 70 61 89 87 98 15 22 87 65 48 85 19 214 144 44 35 113 81 8 363 2000 295 439 957 2,777 409 492 2,809 23 10 10 95 81 91 15 16 83 73 56 100 18 213 169 44 36 122 135 11 469 2001 330 418 1,037 2,642 531 568 2,877 22 70 76 107 79 132 12 17 86 91 65 104 17 209 154 43 35 157 169 13 467 2002 436 417 1,002 2,581 508 544 2,876 22 61 82 108 78 268 13 12 106 95 69 102 16 205 171 42 34 174 189 14 490 2003 561 394 895 2,378 466 445 2,648 20 55 78 105 74 348 13 10 91 93 61 107 16 169 187 42 31 164 195 14 535 2004 798 416 985 2,393 457 482 3,082 24 55 77 103 81 422 11 6 103 94 68 116 15 194 197 46 29 167 224 15 633 2005 878 402 1,039 2,270 429 436 3,168 21 43 77 85 81 897 8 5 96 96 65 122 12 130 129 44 29 163 221 15 655 Total 4,193 4,235 9,605 26,461 4,151 1,256 27,898 207 598 677 813 672 2,415 113 116 881 758 500 971 141 1,753 1,455 418 298 1334 1,310 103 4,524
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Panel A: Distribution of Firms by Year Country 1996 1997 Mexico The Netherlands New Zealand Norway Pakistan Peru Philippines Poland Portugal Russian Federation Singapore South Africa Spain Sweden Switzerland Taiwan Thailand Turkey Total 33 99 13 43 3 1 18 0 21 0 140 46 79 58 95 26 141 9 8,901 38 135 21 70 4 3 40 10 44 6 147 73 97 93 120 50 179 19 10,212
1998 58 139 37 86 16 15 98 28 37 9 187 75 94 119 132 145 198 35 11,166
1999 52 140 43 82 38 17 103 35 40 10 176 100 96 139 128 152 238 28 11,160
2000 47 144 53 76 39 19 97 36 32 13 220 103 102 146 146 159 234 40 11,874
2001 46 148 49 93 42 18 88 32 30 14 229 131 102 205 161 166 228 37 12,347
2002 50 138 58 102 29 18 101 25 32 17 311 147 97 215 158 193 235 29 12,670
2003 49 123 55 89 32 19 103 19 29 18 309 147 96 191 148 215 232 27 12,097
2004 52 118 58 103 34 17 101 18 28 17 349 151 101 213 158 243 275 28 13,357
2005 58 119 65 104 32 17 103 17 25 13 381 150 93 210 153 242 265 27 13,690
Total 483 1,303 452 848 269 144 852 220 318 117 2,449 1123 957 1,589 1,399 1,591 2,225 279 117,474
Panel B: Distribution of Firm-Years by Industry (rows add up to 100%) Two-Digit SIC Code 19 Agro/Forest Australia Canada U.K. U.S.A. France 1.96% 0.17 1.13 0.31 1.25 1017 Mining/Constr. 35.56% 27.27 8.66 5.09 4.19 2039 Manuf. 27.47% 38.18 37.72 49.38 48.49 4047 Transp. 2.69% 2.36 3.41 2.69 2.72 48 Comm. 3.29% 5.12 2.21 3.47 2.14 49 Util. 2.41% 3.78 2.33 5.20 1.81 5051 Whls. 3.55% 3.71 5.00 3.46 5.03 5259 Retail 3.84% 4.39 10.22 8.10 7.61 6067 Fin. 1.57% 4.86 2.37 2.74 1.90 7099 Other 17.65% 10.15 26.93 19.56 24.84 Barton, Hansen, and Pownall
Panel B: Distribution of Firm-Years by Industry (rows add up to 100%) Two-Digit SIC Code 19 Agro/Forest Germany Japan Argentina Austria Belgium Brazil Chile China Colombia Czech Republic Denmark Finland Greece Hong Kong Hungary India Indonesia Ireland Israel Italy Korea Luxembourg Malaysia Mexico The Netherlands New Zealand Norway Pakistan 0.54 0.32 3.38 0.00 2.81 1.11 5.80 1.53 0.00 0.00 0.00 0.00 1.60 0.00 0.00 0.00 2.51 0.00 0.00 1.05 0.00 0.00 5.53 0.00 0.00 8.41 0.71 0.00 1017 Mining/Constr. 2.70 7.26 1.45 9.36 8.27 3.08 2.38 2.40 0.00 13.79 5.68 2.51 12.60 3.60 0.00 1.65 5.84 25.36 1.01 4.95 4.50 5.83 9.79 8.49 6.83 1.99 12.15 7.81 2039 Manuf. 55.59 54.41 58.45 63.88 52.88 61.25 43.01 61.16 77.88 28.45 59.70 63.59 53.00 39.24 67.38 81.06 63.30 36.36 53.69 60.49 69.24 23.30 53.54 50.31 49.19 29.87 38.92 66.91 4047 Transp. 2.35 4.33 0.00 3.68 1.77 1.60 6.25 8.28 0.00 0.00 7.72 6.46 4.80 6.08 2.84 2.00 5.36 5.98 0.00 4.95 3.97 10.68 4.24 3.52 4.91 12.39 18.75 4.09 48 Comm. 1.83 0.60 9.66 1.34 1.18 11.19 5.80 1.28 0.00 10.34 1.70 1.58 4.80 6.18 9.22 1.20 2.47 0.96 6.71 3.30 3.44 33.01 0.97 7.87 2.15 5.09 2.36 5.20 49 Util. 4.39 0.79 22.22 5.52 4.14 15.13 18.45 5.84 4.42 42.24 1.70 3.69 3.00 3.91 8.51 3.75 0.07 0.00 2.68 8.40 3.21 8.74 2.17 0.00 0.00 10.40 3.18 10.04 5051 Whls. 3.78 10.22 0.00 3.01 6.06 1.11 2.38 1.57 8.85 0.00 7.95 3.43 2.80 10.20 0.00 0.57 9.07 13.16 1.34 1.57 2.98 0.00 5.42 2.90 9.75 5.31 1.65 0.00 5259 Retail 3.64 10.29 3.38 2.68 8.86 3.81 4.45 3.02 8.85 0.00 3.29 2.24 6.60 5.77 0.00 0.34 3.99 2.15 2.68 3.45 3.59 7.77 3.21 18.22 4.76 11.50 4.13 2.60 6067 Fin. 4.04 0.92 0.00 1.67 2.95 0.74 5.06 0.66 0.00 0.00 0.45 0.33 0.60 7.83 0.00 0.00 0.96 0.24 7.72 1.05 0.46 0.00 4.91 0.00 0.38 2.65 0.94 0.00 7099 Other 21.12 10.86 1.45 8.86 11.08 0.98 6.40 14.24 0.00 5.17 11.80 15.83 10.20 17.20 12.06 9.41 5.43 15.79 24.16 10.79 8.63 10.68 10.23 8.70 22.03 12.39 17.22 3.35
Which Performance Measures Do Investors Around the World Value the Mostand Why? 767
Panel B: Distribution of Firm-Years by Industry (rows add up to 100%) Two-Digit SIC Code 19 Agro/Forest Peru Philippines Poland Portugal Russian Federation Singapore South Africa Spain Sweden Switzerland Taiwan Thailand Turkey Total 0.00 0.00 2.27 0.00 0.00 0.49 0.89 0.52 0.00 0.00 0.00 1.21 0.00 0.84% 1017 Mining/Constr. 30.56 17.49 16.36 12.58 9.40 5.92 20.21 10.24 5.54 1.36 4.90 4.04 2.15 8.20% 2039 Manuf. 43.06 32.98 55.00 47.80 41.03 45.81 30.99 50.37 50.28 63.97 82.59 61.21 75.99 50.69% 4047 Transp. 0.00 5.75 0.00 3.77 5.98 6.78 3.65 4.18 3.78 4.50 4.27 3.50 4.66 3.86% 48 Comm. 6.94 7.98 3.18 7.86 28.21 1.10 4.19 2.72 3.08 0.50 1.19 4.90 3.23 2.52% 49 Util. 13.19 4.58 2.27 2.20 15.38 0.98 0.27 9.30 0.88 6.65 0.00 1.35 3.23 3.22% 5051 Whls. 6.25 1.53 2.73 4.09 0.00 10.09 7.03 2.82 3.84 5.22 1.76 5.12 4.66 5.64% 5259 Retail 0.00 1.88 0.00 11.01 0.00 5.96 11.75 3.76 3.27 4.86 2.45 4.09 6.09 7.13% 6067 Fin. 0.00 10.33 0.00 1.57 0.00 4.49 2.32 5.64 4.28 1.50 0.13 2.20 0.00 2.24% 7099 Other 0.00 17.49 18.18 9.12 0.00 18.37 18.70 10.45 25.05 11.44 2.70 12.36 0.00 15.66%
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Panel C: Median Values of Selected Firm Characteristics ($ Amounts in Millions) Equity Market Market-toStock Country Value Assets Sales Book Equity Return Australia Canada U.K. U.S.A. France Germany Japan Argentina $43 273 126 501 119 100 112 381 $45 295 133 475 191 181 285 844 $30 185 145 445 184 194 295 463 1.69 1.74 1.77 2.07 1.66 1.65 1.00 0.90 10.75% 11.79 5.35 6.09 7.96 0.63 2.40 0.01
Return on Equity 4.49% 6.74 9.27 9.19 9.35 6.54 3.81 7.26
Prot Margin 2.19% 4.27 3.69 3.56 2.83 1.63 1.39 6.33
Reporting Losses 44.36% 31.64 27.10 28.41 22.12 29.44 20.71 28.50
Long-Term Debtto- Assets 4.56% 15.56 7.25 15.71 10.24 6.23 7.50 15.84 (continued on next page) Barton, Hansen, and Pownall
Panel C: Median Values of Selected Firm Characteristics ($ Amounts in Millions) Equity Market Market-toStock Country Value Assets Sales Book Equity Return Austria Belgium Brazil Chile China Colombia Czech Republic Denmark Finland Greece Hong Kong Hungary India Indonesia Ireland Israel Italy Korea Luxembourg Malaysia Mexico The Netherlands New Zealand Norway Pakistan Peru Philippines 86 157 202 217 229 209 162 95 266 300 119 132 116 24 175 390 240 246 834 34 613 229 107 130 66 133 18 214 250 795 322 294 436 425 157 296 348 286 206 208 79 218 447 443 827 1,363 72 1,353 356 127 182 121 274 71 224 243 603 156 147 225 284 170 315 240 159 207 195 61 214 254 317 698 848 42 1,071 471 122 144 114 151 224 1.20 1.55 0.65 1.16 1.75 0.62 0.61 1.28 1.59 2.10 0.76 1.09 1.31 0.85 1.92 1.58 1.51 0.79 1.48 0.95 1.11 1.93 1.55 1.63 1.35 0.80 0.58 1.04 7.97 5.57 7.35 13.87 6.84 5.68 6.42 13.78 4.13 0.56 3.78 9.43 6.01 8.04 8.68 8.39 26.91 9.10 6.25 10.51 2.89 16.03 9.64 17.49 14.30 3.42
Return on Equity 8.04 9.72 8.54 8.31 6.18 5.41 6.49 8.62 11.49 10.18 5.89 9.98 13.78 7.99 10.04 7.24 6.06 8.18 3.13 5.23 11.43 13.87 10.46 7.82 19.72 9.50 2.14
Prot Margin 2.74 3.26 4.79 8.08 4.54 7.98 7.07 3.02 4.31 5.98 6.11 6.50 6.73 2.39 4.34 5.02 2.93 3.64 0.89 3.98 5.68 3.22 5.80 3.07 7.06 9.37 2.95
Reporting Losses 20.57 18.91 26.32 13.54 13.04 13.27 10.34 19.07 15.57 8.10 24.72 11.33 9.24 35.81 31.34 30.54 23.76 16.56 39.81 28.51 14.70 17.50 14.60 30.78 11.90 12.50 41.78
Long-Term Debtto- Assets 10.00 11.88 14.79 13.16 1.98 4.30 7.24 13.11 15.01 8.93 5.18 4.50 17.20 9.87 14.93 12.48 9.79 10.65 16.24 4.08 17.02 11.14 20.64 20.39 8.46 12.24 2.89
769
Panel C: Median Values of Selected Firm Characteristics ($ Amounts in Millions) Equity Market Market-toStock Country Value Assets Sales Book Equity Return Poland Portugal Russian Fed Singapore South Africa Spain Sweden Switzerland Taiwan Thailand Turkey 99 157 1714 49 229 412 125 272 323 24 351 151 470 3,750 92 285 514 148 415 508 58 251 186 363 2,027 66 311 380 162 380 343 51 311 1.14 1.50 1.03 1.05 1.60 1.73 1.86 1.55 1.38 0.88 2.05 7.19 6.99 47.47 4.74 15.70 17.14 7.20 8.90 2.68 3.66 2.09
770
Return on Equity 6.89 7.63 8.15 5.12 17.01 11.04 8.97 9.46 7.82 9.64 15.87
Prot Margin 3.35 2.92 8.82 3.47 5.62 6.05 3.10 4.21 4.92 5.05 5.89
Reporting Losses 15.91 16.04 10.26 26.17 13.27 7.63 31.53 13.94 20.68 23.64 13.62
Long-Term Debtto- Assets 2.56 16.33 8.61 4.97 3.96 10.60 9.63 14.41 10.64 6.10 4.35
The nal sample consists of 117,474 observations for 19,784 public rms over 19962005 with data available on Compustats Global Vantage. Returns and margins are measured over the rms scal year.
771
IV. WHICH PERFORMANCE MEASURES ARE MOST VALUE RELEVANT? We examine eight summary performance measures: total sales SALES ; operating earnings before interest, income taxes, depreciation and amortization EBITDA ; operating income before income taxes OPINC ; income before income taxes IBTAX ; income before extraordinary items and discontinued operations IBXIDO ; net income NI ; total comprehensive income TCI ; and operating cash ows OCF . All measures are scaled by the lagged market value of common equity. Our proxy for summary performance measure js value RELEVANCE in country k is the adjusted R2 from the regression: RETURNit,k =
0,jk
1,jk
it,k
it,k ,
where RETURN is rm is stock return for scal year t, net of the average stock return for that year in the rms country k using all rms with available stock return data in that country , and performance measure j SALES, EBITDA, OPINC, IBTAX, IBXIDO, NI, TCI, OCF . Larger values of RELEVANCE imply that performance measure j is more relevant for equity valuation. Table 3 reports the value relevance of each of our eight performance measures for each country. To provide a visual summary, the greatest value of RELEVANCE in each country appears in bold. The performance measure with the greatest value relevance varies substantially across countries. IBTAX is the most value relevant measure in 25 of the 46 countries, including Australia, Canada, the United States, and France. However, each of the other performance measures, with the exception of SALES, is the most value relevant in at least one country. For instance, in the U.K. and Germany, EBITDA is the most value relevant performance measure; in Japan, OPINC is the most value relevant. Furthermore, the performance measure exhibiting the greatest value relevance does not follow a simple, easily distinguishable pattern, such as a code-law versus common-law dichotomization. The magnitude of our estimates of value relevance also varies widely between performance measures for example, OPINC varies from 0.010 in Luxembourg to 0.295 in Russia . The distribution of value relevance measures among the seven countries at the top of the table is considerably tighter, ranging from 0.003 for SALES in Canada to 0.117 for IBTAX in France. To formalize these relative patterns in value relevance, Table 4 presents results of estimating these models: RELEVANCE jk = + +
0
1DUM_SALES jk
2DUM_EBITDA jk
3DUM_OPINC jk
4DUM_IBTAX jk jk ,
5DUM_IBXIDO jk
6DUM_NI jk
7DUM_TCI jk
RELEVANCE jk = 1 + COMMON jk + +
3DUM_OPINC jk 6DUM_NI jk
1DUM_SALES jk
2DUM_EBITDA jk
4DUM_IBTAX jk
5DUM_IBXIDO jk
7DUM_TCI jk
jk ,
RELEVANCE jk = + +
1UPTO_SALES jk
2UPTO_EBITDA jk
3UPTO_OPINC jk
4UPTO_IBTAX jk 7UPTO_TCI jk
+
jk,
5UPTO_IBXIDO jk
6UPTO_NI jk
and
772
TABLE 3 Value Relevance of Performance Measures across Countries
Country Australia Canada U.K. U.S.A. France Germany Japan Argentina Austria Belgium Brazil Chile China Colombia Czech Republic Denmark Finland Greece Hong Kong Hungary India Indonesia Ireland Israel Italy Korea
SALES 0.013 0.003 0.012 0.007 0.018 0.028 0.005 0.039 0.015 0.005 0.001 0.004 0.008 0.007 0.002 0.002 0.028 0.002 0.009 0.006 0.023 0.027 0.002 0.013 0.009 0.025
EBITDA 0.031 0.039 0.081 0.037 0.073 0.077 0.063 0.089 0.038 0.035 0.001 0.056 0.048 0.106 0.009 0.050 0.109 0.019 0.035 0.082 0.040 0.138 0.009 0.022 0.070 0.049
OPINC 0.027 0.042 0.073 0.038 0.109 0.074 0.102 0.085 0.056 0.117 0.001 0.067 0.060 0.072 0.008 0.104 0.150 0.035 0.027 0.079 0.048 0.095 0.011 0.028 0.098 0.084
IBTAX 0.032 0.063 0.065 0.039 0.117 0.076 0.070 0.031 0.091 0.162 0.001 0.133 0.063 0.170 0.059 0.127 0.180 0.059 0.047 0.177 0.066 0.038 0.028 0.059 0.121 0.092
IBXIDO 0.027 0.054 0.053 0.030 0.097 0.062 0.055 0.030 0.089 0.143 0.001 0.136 0.055 0.137 0.044 0.117 0.158 0.059 0.047 0.156 0.060 0.030 0.021 0.044 0.104 0.074
NI 0.024 0.053 0.053 0.026 0.095 0.056 0.055 0.031 0.089 0.142 0.001 0.137 0.055 0.137 0.039 0.117 0.167 0.059 0.047 0.155 0.057 0.049 0.024 0.071 0.104 0.074
TCI 0.024 0.046 0.041 0.027 0.065 0.034 0.051 0.005 0.045 0.063 0.001 0.021 0.030 0.080 0.000 0.052 0.129 0.001 0.035 0.147 0.049 0.030 0.004 0.064 0.047 0.042
OCF 0.026 0.036 0.051 0.029 0.030 0.050 0.020 0.014 0.023 0.016 0.001 0.054 0.028 0.066 0.007 0.013 0.068 0.013 0.022 0.049 0.028 0.059 0.002 0.034 0.033 0.058
TABLE 3 (continued)
Country Luxembourg Malaysia Mexico The Netherlands New Zealand Norway Pakistan Peru Philippines Poland Portugal Russian Federation Singapore South Africa Spain Sweden Switzerland Taiwan Thailand Turkey
SALES 0.009 0.021 0.002 0.010 0.011 0.014 0.021 0.006 0.007 0.016 0.003 0.106 0.012 0.062 0.032 0.007 0.034 0.008 0.031 0.004
EBITDA 0.009 0.062 0.031 0.042 0.137 0.054 0.130 0.018 0.016 0.049 0.077 0.273 0.105 0.210 0.080 0.105 0.072 0.101 0.084 0.042
OPINC 0.010 0.053 0.050 0.051 0.181 0.007 0.177 0.044 0.005 0.055 0.108 0.295 0.092 0.205 0.121 0.118 0.109 0.111 0.059 0.045
IBTAX 0.003 0.050 0.021 0.062 0.223 0.083 0.162 0.053 0.001 0.137 0.068 0.216 0.093 0.168 0.131 0.126 0.114 0.106 0.030 0.075
IBXIDO 0.001 0.041 0.006 0.051 0.209 0.091 0.109 0.069 0.001 0.127 0.045 0.204 0.081 0.140 0.126 0.120 0.102 0.101 0.025 0.066
NI 0.001 0.041 0.009 0.050 0.210 0.097 0.106 0.070 0.001 0.127 0.044 0.209 0.076 0.113 0.126 0.119 0.099 0.101 0.032 0.075
TCI 0.025 0.030 0.004 0.037 0.156 0.061 0.108 0.077 0.003 0.054 0.034 0.029 0.052 0.080 0.070 0.071 0.081 0.074 0.030 0.015
OCF 0.010 0.030 0.010 0.013 0.061 0.047 0.159 0.031 0.022 0.008 0.021 0.149 0.033 0.117 0.032 0.073 0.057 0.054 0.059 0.022
The sample consists of 117,747 observations for 19,784 public rms over 19962005 with data available on Compustats Global Vantage. We dene the value relevance of performance measure j RELEVANCE as the adjusted R2 from the regression: RETURNit,jk = 0,jk + 1,jk Performance Measure j it,jk + it,jk for country k, where performance measure j SALES, EBITDA, OPINC, IBTAX, IBXIDO, NI, TCI, OCF .
(continued on next page) 773
774
TABLE 3 (continued)
Variable Denitions: RETURN buy-and-hold stock return over scal year t, net of the median stock return for that year in country k; SALES total sales; EBITDA operating earnings before interest, income taxes, depreciation, and amortization; OPINC operating income before income taxes; IBTAX income before income taxes; IBXIDO income before extraordinary items and discontinued operations; NI net income; TCI total comprehensive income; and OCF operating cash ows. All variables are scaled by lagged market value of common equity. The largest value relevance estimate for each country appears in bold.
TABLE 4 Relative and Incremental Value Relevance of Summary Performance Measures

Panel A: Relative Value Relevance RELEVANCEjk
0 1DUM_SALESjk 7DUM_TCIjk jk 2DUM_EBITDAjk 3DUM_OPINCjk 4DUM_IBTAXjk 5DUM_IBXIDOjk 6DUM_NIjk
(7)
RELEVANCEjk
COMMONjk
5DUM_IBXIDOjk
1DUM_SALESjk 6DUM_NIjk
2DUM_EBITDAjk jk
3DUM_OPINCjk
4DUM_IBTAXjk
7DUM_TCIjk
(8) Equation (8)
Performance Measure Indicator Intercept i.e., DUM_OCF DUM_SALES DUM_EBITDA DUM_OPINC DUM_IBTAX DUM_IBXIDO DUM_NI DUM_TCI Adj. R2
Equation (7) Coefcient 0.033 0.022 0.027 0.039 0.034 0.023 0.022 0.009 0.32 p-value 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.18
COMMON Coefcient 0.030 0.019 0.036 0.063 0.052 0.039 0.039 0.019 0.45
0 p-value 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.01
COMMON Coefcient 0.036 0.025 0.018 0.016 0.016 0.007 0.005 0.002
1 p-value 0.00 0.00 0.00 0.00 0.00 0.08 0.29 0.50
775
Panel B: Incremental Value Relevance The Accounting Review American Accounting Association May 2010 776 RELEVANCEjk
0 1UPTO_SALESjk 7UPTO_TCIjk jk 2UPTO_EBITDAjk 3UPTO_OPINCjk 4UPTO_IBTAXjk 5UPTO_IBXIDOjk 6UPTO_NIjk
(9)
RELEVANCEjk
COMMONjk
6UPTO_NIjk
1UPTO_SALESjk jk
2UPTO_EBITDAjk
3UPTO_OPINCjk
4UPTO_IBTAXjk
5UPTO_IBXIDOjk
7UPTO_TCIjk
(10) Equation (10)
Performance Measure Indicator Intercept i.e., UPTO_OCF UPTO_SALES UPTO_EBITDA UPTO_OPINC UPTO_IBTAX UPTO_IBXIDO UPTO_NI UPTO_TCI Adj. R2
Equation (9) Coefcient 0.033 0.022 0.049 0.013 0.006 0.011 0.001 0.013 0.32 p-value 0.00 0.00 0.00 0.10 0.40 0.00 0.25 0.00
COMMON Coefcient 0.030 0.019 0.055 0.028 0.012 0.013 0.000 0.019 0.45
0 p-value 0.00 0.00 0.00 0.00 0.26 0.00 0.89 0.02
COMMON Coefcient 0.036 0.025 0.043 0.002 0.000 0.009 0.002 0.006
1 p-value 0.00 0.00 0.00 0.30 0.95 0.00 0.07 0.08
The sample consists of seven attributes for each of eight performance measures estimated for 46 countries, using 117,474 observations for 19,784 public rms with data available on Compustats Global Vantage over 19962005. RELEVANCE and the performance measures SALES, EBITDA, OPINC, IBTAX, IBXIDO, NI, TCI, and OCF are all dened in Table 3. COMMON is an indicator coded 1 if the observation pertains to a common-law country i.e., Australia, Canada, Hong Kong, India, Ireland, Israel, Malaysia, New Zealand, Pakistan, Singapore, South Africa, Thailand, the U.K., and the U.S.A. . The indicators DUM_j are coded 1 for observations where the dependent variable pertains to performance measure j, and the indicators UPTO_j are coded 1 for observations where the dependent variable pertains to performance measure j or any other performance measure above it on the income statement. The regressions reect the frequency of rm-years per country, as reported in Table 1. The coefcients are standardized i.e., the standardized coefcient on independent variable X is the regular coefcient on X, multiplied by the standard deviation of X and then divided by the standard deviation of the dependent variable RELEVANCE . All p-values are two-tailed, based on heteroscedasticity-consistent standard errors clustered by country.
777
FIGURE 1 Value Relevance of Summary Performance Measures

0.16 0.14
Value Relvance (in %)
0.12 0.10 0.08 Code 0.06 0.04 0.02 0.00 OCF SALES EBITDA B OPINC C IBTAX IBXIDO NI TCI
Summary Per rformance Mea asure
Common m
RELEVANCE jk = 1 + COMMON jk + +
3UPTO_OPINC jk 6UPTO_NI jk
1UPTO_SALES jk
2UPTO_EBITDA jk
4UPTO_IBTAX jk
5UPTO_IBXIDO jk
7UPTO_TCI jk
jk ,
10
where the dependent variable is the value relevance of measure j in country k estimated and reported in Table 3, the performance measures j are as previously dened, COMMON is an indicator coded 1 if the observation is from a common-law country, the indicators DUM_j are coded 1 for observations where the dependent variable pertains to performance measure j, and the indicators UPTO_j are coded 1 for observations where the dependent variable pertains to performance measure j or any other performance measure above it on the income statement.8 Table 4 and Figure 1 present the results of estimating Equations 7 10 . The results for Equation 7 reported in Table 4, Panel A show that RELEVANCE tends to increase as one moves toward the middle of the income statement, with OPINC having the largest value relevance about twice as strong as our benchmark OCF. SALES is the only accrual-based summary performance measure with value relevance statistically and economically lower than that of OCF. The results for Equation 8 , also reported in Panel A, show a similar pattern for rms in code-law countries, with value relevance about three times larger for OPINC than for cash ows. As highlighted in Figure 1, this pattern is less pronounced for rms in common-law countriesvalue relevance is essentially similar for EBITDA, OPINC, and IBTAX. Highly transitory items like
8
For example, if the observation relates to the value relevance of SALES, then DUM_SALES is coded 1 and all other DUM_j indicators in Equations 7 and 8 are coded 0. In Equations 9 and 10 , UPTO_SALES is coded 1 and all other UPTO_j indicators are coded 0. On the other hand, if the observation relates to the value relevance of IBXIDO, then DUM_IBXIDO is coded 1 and the other DUM_j indicators in Equations 7 and 8 are coded 0; in Equations 9 and 10 , UPTO_SALES, UPTO_EBITDA, UPTO_OPINC, UPTO_IBTAX, and UPTO_IBXIDO i.e., all UPTO_j indicators for performance measures as one moves down the income statement up to and including IBXIDO are coded 1, whereas UPTO_NI and UPTO_TCI which are reported below IBXIDO in the income statement are coded 0. The baseline in these regressions is for observations relating to OCF, in which case all DUM_j and UPTO_j indicators are coded 0.
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extraordinary items, discontinued operations, and other comprehensive income do not appear incrementally useful in common-law countries. Together, the results in Panel A show that value relevance tends to peak for summary performance measures above the line, but less so for rms in common-law countries. Performance measures that include operating costs appear to be much more useful for valuation than measures without cost data or cash-based measures. Equations 9 and 10 are equivalent to Equations 7 and 8 , but they highlight the nding that some performance measures have statistically indistinguishable value relevance. For example, results for Equation 9 reported in Panel B of Table 4 suggest that EBITDA, OPINC, and IBTAX are essentially similar in terms of value relevance, as the coefcients of the last two measures are not statistically signicant. Based on regression results for Equation 10 , one can conclude that, as one moves down the income statement, IBTAX does not add to the value relevance of OPINC, and that NI is essentially similar to IBXIDO. In common-law countries, no additional value relevance is gained by reporting depreciation and amortization expenses or nonoperating income, as evidenced by the coefcients on UPTO_OPINC, and UPTO_IBTAX not being statistically signicant. However, when included in a performance measure, income taxes and highly transitory items like extraordinary items, discontinued operations, and comprehensive income appear to garble information in that performance measure, decreasing its value relevance. Table 5 reports descriptive statistics for the eight performance measures Panel A and the seven underlying attributes Panel B , along with the mean value of each attribute for each performance measure Panel C . SALES is the most persistent and predictable performance measure, and both persistence and predictability decrease monotonically as one moves down the income statement toward TCI. However, SALES is the least smoothed performance measure relative to OCF. In fact, while all other performance measures have smaller standard deviations than OCF, SALES has an average standard deviation that is more than seven times the standard deviation of OCF. Panel C of Table 5 also shows that OCF, EBITDA, and OPINC are the best predictors of next periods cash ows, and OPINC and EBITDA are the closest to current years OCF. The timeliness of the performance measures peaks at EBITDA and then decreases as one moves down the income statement toward TCI. This result is likely driven by the inclusion of more transitory items in the later subtotals and TCI. In contrast, IBTAX, IBXIDO, and NI are the most conservative performance measures, possibly reecting managers incentives to push bad news down the income statement McVay 2006 . The standard deviation of each performance measures attributes also appears in Table 5. Since each attribute is measured at the country level, these standard deviations indicate that the attributes vary across countries. Indeed, all of the attributes exhibit substantial variation for each performance measure, with the exceptions of SMOOTHNESS and SUSBT_OCF. The largest variation is for PREDICT_OCF, which has a coefcient of variation greater than 1 for IBTAX, IBXIDO, NI, and TCI. Together, the results shown in Tables 35 indicate that the relevance and underlying attributes of the different performance measures we examine vary both within the statements of nancial performance and also across countries. In the following sections we investigate the association between the attributes of a performance measure and its value relevance. V. WHY ARE SOME PERFORMANCE MEASURES MORE VALUE RELEVANT THAN OTHERS? Relations among the Attributes The literature usually views the various performance measure attributes as distinct see, e.g., Leuz et al. 2003; Schipper and Vincent 2003; Francis et al. 2004 . However, as Panel A of Table 6 shows, most of these attributes are strongly correlated with each other. For example, PERSIS-
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TABLE 5 Descriptive Statistics of Performance Measures and Their Attributes

Panel A: Descriptive Statistics of Performance Measures (n 117,474) Performance Measure Mean Std. Dev. SALES EBITDA OPINC IBTAX IBXIDO NI TCI OCF 2.54 0.20 0.11 0.05 0.01 0.01 0.02 0.13 939,792) Std. Dev. 0.03 0.19 0.19 2.25 0.10 0.31 0.29 0.23 Q1 0.03 0.39 0.13 0.62 0.02 0.21 0.12 0.15 Median 0.04 0.52 0.23 0.88 0.06 0.37 0.22 0.06 Q3 0.06 0.68 0.43 1.05 0.15 0.67 0.42 0.15 9.98 2.35 1.73 1.34 1.13 1.13 1.16 1.25
Q1 0.61 0.07 0.03 0.01 0.00 0.00 0.02 0.02
Median 1.42 0.15 0.09 0.07 0.05 0.05 0.05 0.10
Q3 3.02 0.26 0.16 0.13 0.09 0.09 0.10 0.19
Panel B: Descriptive Statistics of Attributes (n Attribute Mean RELEVANCE PERSISTENCE PREDICTABILITY SMOOTHNESS PREDICT_OCF SUBST_OCF TIMELINESS CONSERVATISM 0.05 0.52 0.28 1.62 0.09 0.44 0.32 0.01
Panel C: Means and Standard Deviations (in Parentheses) of Attributes by Performance Measure (n 117,474) SALES EBITDA OPINC IBTAX IBXIDO NI PERSISTENCE PREDICTABILITY 0.83 0.07 0.66 0.09 0.66 0.08 0.43 0.09 0.61 0.08 0.36 0.08 0.49 0.09 0.21 0.07 0.47 0.10 0.18 0.07 0.44 0.10 0.16 0.07
TCI 0.29 0.15 0.09 0.06
OCF 0.38 0.12 0.16 0.09
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Panel C: Means and Standard Deviations (in Parentheses) of Attributes by Performance Measure (n 117,474) SALES EBITDA OPINC IBTAX IBXIDO NI SMOOTHNESS PREDICT_OCF SUBST_OCF TIMELINESS CONSERVATISM 7.31 1.79 0.07 0.07 0.03 0.02 0.23 0.07 0.37 0.08 0.77 0.16 0.21 0.08 0.63 0.11 0.46 0.10 0.20 0.19 0.63 0.17 0.12 0.08 0.65 0.17 0.30 0.11 0.02 0.16 0.82 0.22 0.05 0.07 0.34 0.14 0.17 0.10 0.15 0.12 0.70 0.22 0.04 0.06 0.35 0.16 0.16 0.10 0.20 0.13 0.75 0.26 0.03 0.06 0.33 0.16 0.15 0.09 0.19 0.12
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TCI 0.99 0.36 0.02 0.05 0.23 0.12 0.12 0.08 0.16 0.13
OCF 1.00 0.00 0.16 0.09 1.00 0.00 1.00 0.00 0.00 0.00
The sample consists of seven attributes for each of eight performance measures estimated for 46 countries, using 117,474 observations for 19,784 public rms with data available on Compustats Global Vantage over 19962005. All statistics are weighted by the number of rm-years in each country, listed in Table 1. The performance measures are SALES, EBITDA, OPINC, IBTAX, IBXIDO, NI, TCI, and OCF, all dened in Table 3. Various Attributes: PERSISTENCE PREDICTABILITY SMOOTHNESS PREDICT_OCF SUBST_OCF OCFit,jk TIMELINESS NEG CONSERVATISM slope coefcient from the regression of each performance measure j on its lagged value: Performance Measure j it+1,jk = 0,jk + 1,jk Performance Measure j it,jk + it,jk; adjusted R2 from the regression of each performance measure j on its lagged value: Performance Measure j it+1,jk = 0,jk + 1,jk Performance Measure j it,jk + it,jk; slope coefcient from the regression: sd Performance Measure j it,jk = 1,jksdOCFit,jk + it,jk of the standard deviation of performance measure j on the standard deviation of OCF, both deviations measured over the sample period. adjusted R2 from the regression: OCFit+1,jk = 0,jk + 1,jk Performance Measure j it,jk + it,jk of operating cash ows on the lagged value of performance measure j; slope coefcient from the regression; 0,jk + 1,jk Performance Measure j it,jk + it,jk of operating cash ows on the contemporaneous value of performance measure j; adjusted R2 from the regression: Performance Measure j it,jk = 0,jk + 1,jkNEGit,k + 2,jkOCFit,k + 3,jkNEGit,k OCFit,k + it,jk; indicator coded 1 if OCF 0, 0 otherwise; and asymmetric timeliness coefcient 3,jk from the regression used to estimate TIMELINESS. The coefcient is standardized i.e., multiplied by the standard deviation of the interaction NEGk OCFk, then divided by the standard deviation of the performance measure j in country k .
TABLE 6 Factor Analysis of Performance Measure Attributes

Panel A: Pearson and Multiple Squared Correlations R2 among Attributes (1) (2) (3) 1 2 3 4 5 6 7 PERSISTENCE PREDICTABILITY SMOOTHNESS PREDICT_OCF SUBST_OCF TIMELINESS CONSERVATISM 1.00 0.94 0.57 0.37 0.15 0.02 0.56 1.00 0.70 0.39 0.19 0.02 0.71 (4) (5) (6) R2 0.92 0.96 0.85 0.69 0.87 0.84 0.68
1.00 0.05 0.50 0.08 0.59
1.00 0.51 0.61 0.24
1.00 0.79 0.02
1.00 0.15
Panel B: Principal Component Factors Factor Eigenvalue 1 2 3 4 5 6 7 3.20 2.39 0.66 0.41 0.26 0.06 0.03
Percentage Explained 45.7% 34.1 9.4 5.8 3.8 0.8 0.4
Cumulative Percentage 45.7% 79.8 89.2 95.0 98.8 99.6 100.0
Panel C: Rotated Factor Loadings (for Two Factors Retained) and Unique Variances of Attributes Attribute FACTOR1 FACTOR2 PERSISTENCE PREDICTABILITY SMOOTHNESS PREDICT_OCF SUBST_OCF TIMELINESS CONSERVATISM 0.90 0.97 0.80 0.34 0.24 0.02 0.79 0.03 0.03 0.33 0.78 0.92 0.90 0.13
Uniqueness 0.19 0.05 0.26 0.27 0.11 0.19 0.35 (continued on next page)
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Panel D: Pearson and Multiple Squared Correlations R2 between Attributes and Rotated Factors FACTOR2 FACTOR1 (Articulation with Cash Attribute (Sustainability) Flows) PERSISTENCE PREDICTABILITY SMOOTHNESS PREDICT_OCF SUBST_OCF TIMELINESS CONSERVATISM 0.90 0.97 0.80 0.35 0.22 0.04 0.80 0.05 0.05 0.31 0.79 0.91 0.90 0.14
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R2 0.81 0.95 0.74 0.74 0.89 0.81 0.65
Panel E: Pearson Correlations between Performance Measures and Rotated Factors Performance Measure SALES EBITDA OPINC IBTAX IBXIDO NI TCI OCF FACTOR1 (Sustainability) 0.16 0.15 0.16 0.17 0.18 0.18 0.16 0.12 FACTOR2 (Articulation with Cash Flows) 0.30 0.31 0.32 0.34 0.34 0.34 0.34 0.26
The sample consists of seven attributes for each of eight performance measures estimated for 46 countries, using 117,474 observations for 19,784 public rms with data available on Compustats Global Vantage over 19962005. The performance measures are SALES, EBITDA, OPINC, IBTAX, IBXIDO, NI, TCI, and OCF, all dened in Table 3. The various attributes are dened in Table 5. Oblique promax rotation allows the retained factors to be correlated with, rather than orthogonal to, each other. The correlations and factor analysis reect the frequency of rm-years per country as shown in Table 1.
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TENCE is positively correlated with PREDICTABILITY and SMOOTHNESS; the latter is negatively correlated with SUBST_OCF, TIMELINESS, and CONSERVATISM. The strongest correlation between any two attributes is the 0.94 correlation between PERSISTENCE and PREDICTABILITY; both the mean and median Pearson correlations, in absolute values, between any two variables are 0.39. A Bartlett 1950 test of the signicance of the correlation table rejects 0.001 . The last column of the null that the variables are not correlated 2 21 df = 1,496.4; p Panel A shows that multiple squared correlations between each attribute and the rest ranges from 0.68 to 0.96, suggesting that at least two thirds of the variation in each attribute can be explained by the other attributes. This strong correlation structure raises two issues. First, regression coefcient estimates may be biased due to collinearity, so we may be unable to determine reliably which attributes are associated with more value relevant performance measures. Second, and more important, the seven attributes we focus on may indeed be capturing fewer underlying attribute dimensions of the various performance measures. We address these two issues by performing a principal components factor analysis on the seven performance measure attributes. The analysis takes into account the number of rm-years used to estimate each attribute; such frequency weighting reects the relative number of rms in each country that would be affected by changes in nancial reporting standards involving the performance measures denitions or attributes. Correlations and factor analyses without this frequency weighting are qualitatively similar to those reported in Table 6. The eigenvalue-greaterthan-1 rule of thumb, a scree plot, and a parallel analysis all suggest that we retain the rst two factors for further analysis.9 Panel B shows that these rst two factors account for about 80 percent of the total variation in the original seven attributes. To simplify the structure of the factors and facilitate interpretation, we perform an oblique promax rotation of the factors. A benet of oblique rotation is that it allows the factors to be correlated with each other. In our case, the correlation between the two retained, rotated factors is 0.02, suggesting they are essentially orthogonal. Panel C of Table 6 shows the factor loading and uniqueness for each of the seven attributes. Factor loadings are the standardized coefcients from the regressions of each attribute on the factors and, therefore, they are equivalent to partial correlations , and the uniqueness of each attribute is the proportion of its variance not explained by the two retained factors. The latter are consistent with the pattern in the multiple squared coefcients in the last column of Panel A. PERSISTENCE, PREDICTABILITY, and SMOOTHNESS load strongly and positively on the rst factor, FACTOR1, whereas CONSERVATISM loads strongly and negatively on this factor. In
See Gorsuch 1983 for a discussion of factor analysis. The eigenvalues in Panel B of Table 6 are the variances of the factors. The sum of the eigenvalues is equal to the number of variables, so that each eigenvalue divided by 7 is the proportion of the variance of the variables that is explained by that factor. Since the standardized variables each have variance equal to 1, Guttman 1954 and Kaiser 1960 suggest retaining factors with eigenvalues greater than 1 any factor with an eigenvalue less than 1 adds less than would a single variable and, therefore, is not helpful in reducing the dimensionality of the data . Cattell 1966 proposes a scree test as an alternate method for determining how many factors to retain. This test plots the eigenvalues of each factor on the vertical axis and the factor number on the horizontal axis. The determination of how many factors to retain is based on the slope of the graph. The last factor retained is the one at which the slope of the line attens. A parallel analysis Horn 1965 also can be used to determine the number of factors retained. We have not seen it used in the accounting literature, although methodological studies suggest it is the most accurate among common methods for determining the number of factors e.g., Zwick and Velicer 1986 . We implement this analysis by performing a factor analysis on a random data set with the same number of observations and variables as ours; because the variables in this parallel data set are random, any resulting eigenvalues should be uninterpretable. We repeat this random factor analysis 500 times. The results also suggest retaining the rst two factors because the rst two eigenvalues from our real data set are larger than the means of the rst two eigenvalues from the random data set, and the last ve eigenvalues in our real data set are smaller than the means of those from the random data set. Taken together, the criteria we examined indicate a two-factor solution.
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contrast, PREDICT_OCF, SUBST_OCF, and TIMELINESS load strongly and positively on the second factor, FACTOR2. The two factors explain between 65 and 95 percent of the variance of each of the underlying attributes. Panel D of Table 6 presents Pearson correlations between each attribute and the rotated factors. These results suggest some overlap among the various attributes and factors, and the importance of considering all factors simultaneously in further analyses. More important, our results indicate that several of the attributes of accounting performance measures that the prior literature has treated as independent are better represented by a smaller number of underlying factors. In particular, those measures related to the time-series properties of earnings, and measures of the relationship between current earnings and current and future cash ows, are strongly related, capturing primarily only two underlying dimensions. To further help interpret the factors, Panel E of Table 6 presents the Pearson correlations between the factors and mean country-level performance measures. Both FACTOR1 and FACTOR2 appear to have slightly higher correlations with performance measures that are further down the income statement, and the lowest correlations with OCF. Based on the correlations in Panel D and E, we conclude that FACTOR1 captures the notion of sustainability: higher values of FACTOR1 suggest that the performance measure is more persistent, predictable, and smoothed out. FACTOR2, on the other hand, seems to capture the notion of articulation with cash ows, in the sense that higher values of FACTOR2 suggest a performance measure that is less smoothed out, more correlated with current and future cash ows, and, therefore, more timely. It is important to recognize that a high value of FACTOR2 does not imply that the performance measure is closer to cash ows and therefore devoid of accruals, but rather that its accruals are more correlated with cash owsevery Pearson correlation between FACTOR2 and the accrual-based performance measures reported in Panel E of Table 6 is substantially larger in magnitude than the correlation between FACTOR2 and operating cash ows. We extract our factors using principal component factoring, which attempts to explain the total variance of the seven attributes. An alternative approach is to extract the factors using principal common or axis factoring, which explains only the shared variance of the attributes. The Pearson correlation between the principal component factors and the principal common factors is 0.95 for FACTOR1 and 0.98 for FACTOR2, so we only tabulate further results using the former since they yield similar results to those using the latter. Also, we obtain similar inferences when we measure TIMELINESS and CONSERVATISM using stock returns rather than cash ows, that is, consistent with Basu 1997 rather than Ball and Shivakumar 2005 . For instance, the Pearson correlation between cash-ow-based and returns-based principal component factors is 0.91 for FACTOR1 and 0.56 for FACTOR2. Relations between Value Relevance and Performance Measure Attribute Factors To provide descriptive evidence on the relations between value relevance and the two attribute factors, we estimate the following model: RELEVANCE jk =
0
1FACTOR1 jk
2FACTOR2 jk
Country indicator
jk
jk
11
where RELEVANCE is the value relevance of summary performance measure j in country k, FACTOR1 is the sustainability factor, and FACTOR2 is the articulation-with-cash-ows factor. The model includes country indicators to control for country-specic xed effects. i.e., the coefcient We evaluate the magnitude and sign of each standardized coefcient multiplied by the ratio of the standard deviation of the independent variable to the standard deviation of RELEVANCE to assess each factors relative importance in equity valuation. Doing so allows us to interpret the economic as well as statistical signicance of each variable. A positive negative coefcient can be interpreted as the number of standard deviations that the dependent
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variable will increase decrease given a standard deviation increase in the independent variable Long 1997, 17 . Consistent with our factor analysis, we estimate Equation 11 by taking into account the number of rm-years used to estimate each attribute. Again, this frequency weighting reects the relative number of rms in each country that would be affected by changes in nancial reporting standards involving the performance measures denitions or attributes. Regression results without this frequency weighting lead to similar inferences. All our tests are based on heteroscedasticityconsistent standard errors adjusted for correlation among residuals pertaining to rms in the same country. Table 7 shows estimation results. The second and third columns show coefcient estimates and p-values for simple regressions with each factor as the single independent variable, whereas the last two columns show coefcient estimates and p-values for a multiple regression including the two factors simultaneously. The multiple regressions adjusted R2 suggests that the two factors together explain about half of the variation in a performance measures value relevance. The association between value relevance and the sustainability factor FACTOR1 is negative and signicant in both regressions. This negative association may reect actions taken by rms to increase the smoothness or measured persistence of the earnings and earnings-related measures. Recall that Tables 35 suggest that value relevance in most countries peaks at above the line
TABLE 7 Association between Value Relevance and Factors Derived from Performance Measure Attributes
Simple Regressions: RELEVANCE jk = + +
jk, 1FACTOR jk
Country Indicator
jk
where FACTOR
FACTOR1,FACTOR2
Multiple Regression: RELEVANCE jk = +
+
k
1FACTOR1 jk k
2FACTOR2 jk jk
Country Indicator
jk
Simple Regressions Attribute FACTOR1 Sustainability FACTOR2 Articulation with Cash Flows Adj. R2 Coefcient 0.162 0.059 0.46 and 0.52 p-value 0.00 0.01
Multiple Regression Coefcient 0.160 0.054 0.52 p-value 0.00 0.04
The sample consists of seven attributes for each of eight performance measures estimated for 46 countries, using 117,474 observations for 19,784 public rms with data available on Compustats Global Vantage over 19962005. The performance measures are SALES, EBITDA, OPINC, IBTAX, IBXIDO, NI, TCI, and OCF, all dened in Table 3. The factors are reported in Table 6. The regressions reect the frequency of rm-years per country, as reported in Table 1. The coefcients are standardized i.e., the standardized coefcient on independent variable X is the regular coefcient on X, multiplied by the standard deviation of X and then divided by the standard deviation of the dependent variable RELEVANCE . Country indicator k takes on the value 1 if the attribute relates to a performance measure estimated with data from country k, 0 otherwise. All p-values are two-tailed, based on heteroscedasticity-consistent standard errors clustered by country. Total n is 939,792.
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performance measures such as EBITDA, OPINC, or IBTAX, and then decreases moving down the income statement to measures that capture increasingly more transitory elements of earnings. At the same time, the smoothness of the measures i.e., SMOOTHNESS, measured as the ratio of the standard deviation of the performance measure to the standard deviation of operating cash ows increases monotonically as one moves down the income statement toward TCI. Finally, the coefcient on the cash ow articulation factor FACTOR2 is positive in both regressions, indicating that closeness to current period cash ows, the ability to predict next periods cash ows, and timeliness in capturing bad news i.e., the effects of negative versus positive operating cash ows are useful from a valuation perspective.10 In other words, what seems to make FACTOR2 value relevant is not whether a performance measures accruals are managed or smoothed out, but rather whether they clearly link to current and expected cash receipts and payments. Overall, our results suggest that performance measures become more value relevant when they incorporate economic value added in a timely, unbiased fashion and when their accruals can be articulated with the rms underlying cash ows. In contrast, performance measures that are smoother, more predictable and persistent, and less conservative are less useful for valuation such attributes lower the value relevance of a performance measure. These inferences apply similarly to performance measures reported by rms from the 46 countries represented in our sample. Our nal sample excludes observations at the top and bottom 1 percent of the distributions in each country of each variable included in our analyses. Excluding observations at the top and bottom 2.5 percent lead to similar inferences not tabulated . However, results using all observations are difcult to interpret, suggesting that the most extreme observations are highly inuential. VI. CONCLUSIONS Academics and practitioners have recently begun to move away from proposing better measures of earnings to instead focusing on earnings quality attributessuch as persistence, predictability, smoothness, and timelinessthat may make a particular earnings measure more useful in equity valuation, especially if such attributes capture some dimension of information risk about the rms future performance e.g., Schipper and Vincent 2003; Francis et al. 2004 . Our goal in this paper is to develop an empirical description of the underlying constructs reected in common performance measure attributes, and to generalize that description to multiple performance measures for rms in the global capital market. To this end, we estimate the persistence, predictability, smoothness, and the contemporaneous and lagged association with operating cash ows, timeliness, and conservatism of eight different summary performance measures for almost 20,000 rms in 46 countries during 19962005. Our eight performance measures are sales, EBITDA, operating income, income before income taxes, income before extraordinary items and discontinued operations, net income, total comprehensive income, and operating cash ows. We nd that the performance measures exhibit value relevance that largely follows an inverted U shape, with the lowest value relevance at the top i.e., sales and bottom i.e., total comprehensive income of the income statement and higher value relevance toward the middle of the income statement i.e., operating income and EBITDA . No single performance measure clearly dominates all others, but subtotals generally tend to be more value relevant when they include core operating expenses and exclude more transitory items like extraordinary items, gains and losses, and other comprehensive income. Our comparisons of the performance measures value relevance reect wide variation across countries. The absolute and relative value relevance
10
For related analysis on earnings attributes, see Alford et al. 1993 .
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of the performance measures vary between code- and common-law regimesthe distinction between code and common law introduces additional explanatory power into regressions assessing the value relevance of performance measures across the income statement. Unlike performance measures, the underlying attributes tend to be ranked more consistently across countries and between code- and common-law regimes. In addition, we nd that the seven performance measure attributes we examine are not independent of each other, but rather can be represented by two underlying factors with intuitive associations with the constructs of sustainability and articulation with cash ows. This result suggests that researchers should use care in making inferences regarding individual attributes rather than a reduced set of underlying factors. Our results are relevant to the joint FASB and IASB project on reporting nancial performance. That project considers whether standards should dene and require the reporting of specic subtotals and totalslike operating income, EBITDA, and net incomein the nancial statements FASB 2001, 2 . Our ndings suggest that standard-setters should focus on developing and facilitating performance and cash ow statements that consider the properties of sustainability and articulation with cash ows reected in line items, subtotals, and totals.
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THE ACCOUNTING REVIEW Vol. 85, No. 3 2010 pp.

American Accounting Association DOI: 10.2308/accr.2010.85.3.753

Barton, Hansen, and Pownall

The Accounting Review American Accounting Association

The Accounting Review

May 2010 American Accounting Association

Barton, Hansen, and Pownall

The Accounting Review American Accounting Association

The Accounting Review

May 2010 American Accounting Association

Barton, Hansen, and Pownall

The Accounting Review American Accounting Association

The Accounting Review

May 2010 American Accounting Association

The Accounting Review American Accounting Association May 2010

TABLE 1 Sample Selection

Barton, Hansen, and Pownall

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The Accounting Review May 2010 American Accounting Association

Firms 0 0 129 0 0 0 85 0 0 143 22 0 290 243 76 48 241 0 0 256 0 0 0 0 0 19 764

(continued on next page)

The Accounting Review American Accounting Association May 2010

Firms 3 1 1 113 3 8 1 5 296 144 241 59 3 5 27 196 55 76 2 4 22 9 546 9 8 329 209

Firms 0 0 0 79 0 0 0 0 211 99 166 48 0 0 20 131 41 59 0 0 20 0 470 0 0 226 154

Barton, Hansen, and Pownall

(continued on next page)

The Accounting Review May 2010 American Accounting Association

Firms 7 401 317 342 448 62 1 6 16 1 8 26,479

Firms 0 310 208 288 336 47 0 0 0 0 0 19,784

Barton, Hansen, and Pownall

The Accounting Review American Accounting Association

The Accounting Review May 2010 American Accounting Association

TABLE 2 Sample Description

(continued on next page)

The Accounting Review American Accounting Association May 2010

1998 58 139 37 86 16 15 98 28 37 9 187 75 94 119 132 145 198 35 11,166

(continued on next page)

The Accounting Review May 2010 American Accounting Association

(continued on next page)

The Accounting Review American Accounting Association May 2010

The Accounting Review May 2010 American Accounting Association

(continued on next page)

The Accounting Review American Accounting Association May 2010

Barton, Hansen, and Pownall

The Accounting Review

May 2010 American Accounting Association

The Accounting Review American Accounting Association May 2010

TABLE 3 Value Relevance of Performance Measures across Countries

Barton, Hansen, and Pownall

(continued on next page)

The Accounting Review May 2010 American Accounting Association

(continued on next page) 773

The Accounting Review American Accounting Association May 2010

Barton, Hansen, and Pownall

The Accounting Review May 2010 American Accounting Association

TABLE 4 Relative and Incremental Value Relevance of Summary Performance Measures

(8) Equation (8)

0 p-value 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.01

1 p-value 0.00 0.00 0.00 0.00 0.00 0.08 0.29 0.50

(continued on next page)

(10) Equation (10)

0 p-value 0.00 0.00 0.00 0.00 0.26 0.00 0.89 0.02

1 p-value 0.00 0.00 0.00 0.30 0.95 0.00 0.07 0.08