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Accounting and Economic Rates of Return: a Dynamic Econometric Investigation

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  • Rodrigo M. Zeidan
  • Marcelo Resende

Abstract

Many studies have questioned empirical utilization of accounting data as internal rates of return would be more consistent with the relevant economic concept. The paper investigates the dynamic relationships between different measures of accounting rates of return (ARRs) and different approximations for the internal rates of returns (IRRs). In contrast with the prevailing case-study investigations, one considers a panel for quoted Brazilian firms in the manufacturing industry along the 1988-3/2003-2 period. Granger causality tests are considered and even though the results are not completely clear cut, some discernible uni-directional patterns emerge. In particular, there seems to be informational content between economic and accounting rates of return, between ROA (Net Profits/Total Assets) and PM (Gross Profits/ Operational Income), and internal rates of return. This seems to indicate that there is some validity in using accounting rates of return in certain economic studies.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2006/7.

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Date of creation: 2006
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Handle: RePEc:eui:euiwps:eco2006/7

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  1. Fisher, Franklin M & McGowan, John J, 1983. "On the Misuse of Accounting Rates of Return to Infer Monopoly Profits," American Economic Review, American Economic Association, vol. 73(1), pages 82-97, March.
  2. Granger, C W J, 1969. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods," Econometrica, Econometric Society, vol. 37(3), pages 424-38, July.
  3. Salamon, Gerald L, 1985. "Accounting Rates of Return," American Economic Review, American Economic Association, vol. 75(3), pages 495-504, June.
  4. Salamon, Gerald L., 1988. "On the validity of accounting rates of return in cross-sectional analysis: Theory, evidence, and implications," Journal of Accounting and Public Policy, Elsevier, vol. 7(4), pages 267-292.
  5. Martin, Stephen, 1988. "The measurement of profitability and the diagnosis of market power," International Journal of Industrial Organization, Elsevier, vol. 6(3), pages 301-321.
  6. Feenstra, D.W. & Wang, H., 2000. "Economic and accounting rates of return," Research Report 00E42, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
  7. Fisher, Franklin M, 1984. "The Misuse of Accounting Rates of Return: Reply," American Economic Review, American Economic Association, vol. 74(3), pages 509-17, June.
  8. Salamon, Gerald L, 1989. "Accounting Rates of Return: Reply," American Economic Review, American Economic Association, vol. 79(1), pages 290-93, March.
  9. Christopher Taylor, 1999. "The Cash Recovery Method of Calculating Profitability: An Application to Pharmaceutical Firms," Review of Industrial Organization, Springer, vol. 14(2), pages 135-146, March.
  10. Verma, Kiran, 1990. "Effects of accounting techniques on the study of market power," International Journal of Industrial Organization, Elsevier, vol. 8(4), pages 587-598, December.
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