The relevance of replacement cost asset information to firm valuation

ChangHun (Peter) Park, Purdue University

Abstract

This dissertation examines the relevance of replacement cost asset information to firm valuation. It is proposed that there exists an association between replacement cost asset changes and stock returns, and that the signed magnitude of the association varies positively with firms' future cash flow prospects. It is generally recognized that stock prices reflect information about future earnings that is not captured by the past time series of earnings. This study proposes that such information can be found in asset changes, especially measured in replacement cost. FASB Statement of Concepts No. 6 characterizes assets as "service potential" or "future economic benefit" that will eventually result in net cash flows to the firm, which implies that change in assets indicates change in "cash flow potential" yet to be realized. The extent to which the change in "cash flow potential" is actualized in the future, however, will differ across firms, as the "abilities" to translate: the change in assets into the future net cash flows vary across firms. Tobin's q theory of investment provides a framework in which one can formulate the relation between asset changes, relative future cash flow prospects, and stock returns. Tobin's q theory implies the hypothesis that the extent to which replacement cost asset changes are associated with stock returns varies positively with Tobin's (marginal) q, where Tobin's q indicates a firm's future cash flow prospects. Market association tests are employed. Consistent with previous studies, marginal q's are assumed to be proxied for by average q's. Empirical results are generally consistent with the hypothesis. Empirical evidence without control variables supports the hypothesis. When firm size and historical cost income are controlled for, empirical evidence is still consistent with the hypothesis. When historical cost asset change is also controlled for, although multicollinearity is suspected to dampen the significance of empirical tests, empirical evidence is weakly consistent with the hypothesis. Overall, the empirical results suggest that asset changes, along with earnings, reflect the valuation-relevant information with respect to stock prices, and that Tobin's q serves as a key variable that explains the association between (replacement cost) asset changes and stock returns.

Degree

Ph.D.

Advisors

Ro, Purdue University.

Subject Area

Accounting

COinS