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Accounting Returns Revisited: Evidence of their Usefulness in Estimating Economic Returns

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  • Morris G. Danielson

    (Saint Joseph's University)

  • Eric Press

    (Temple University)

Abstract

Accounting information is used for measuring firm performance in various financial applications—a practice supported by empirical studies demonstrating the value relevance of accounting numbers, but disputed by theoretical papers arguing that a firm's accounting rate of return (ARR) serves poorly as a proxy for its internal rate of return (IRR). We derive a new model of the ARR–IRR relation, and describe how the conservatism of GAAP constrains a firm's IRR to fall in a range bounded by its historical growth rate and ARR. Using cross-sectional data, we demonstrate that economic returns can be estimated from accounting numbers for many firms. We link empirical results to underlying economic theory, and thus contribute to understanding why accounting information is value relevant.

Suggested Citation

  • Morris G. Danielson & Eric Press, 2003. "Accounting Returns Revisited: Evidence of their Usefulness in Estimating Economic Returns," Review of Accounting Studies, Springer, vol. 8(4), pages 493-530, December.
    • Handle: RePEc:spr:reaccs:v:8:y:2003:i:4:d:10.1023_a:1027368116754
    DOI: 10.1023/A:1027368116754
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    References listed on IDEAS

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    1. James J. Heckman, 2001. "Micro Data, Heterogeneity, and the Evaluation of Public Policy: Nobel Lecture," Journal of Political Economy, University of Chicago Press, vol. 109(4), pages 673-748, August.
    2. Ball, R & Brown, P, 1968. "Empirical Evaluation Of Accounting Income Numbers," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 6(2), pages 159-178.
    3. Zhang, Xiao-Jun, 2000. "Conservative accounting and equity valuation," Journal of Accounting and Economics, Elsevier, vol. 29(1), pages 125-149, February.
    4. Fisher, Franklin M., 1988. "Accounting data and the economic performance of firms," Journal of Accounting and Public Policy, Elsevier, vol. 7(4), pages 253-260.
    5. Morris Danielson & Thomas Dowdell, 2001. "The Return-Stages Valuation Model and the Expectations Within a Firm's P/B and P/E Ratios," Financial Management, Financial Management Association, vol. 30(2), Summer.
    6. 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.
    7. Peasnell, Kenneth V., 1996. "Using accounting data to measure the economic performance of firms," Journal of Accounting and Public Policy, Elsevier, vol. 15(4), pages 291-303.
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    Cited by:

    1. Madhav V. Rajan & Stefan Reichelstein & Mark T. Soliman, 2007. "Conservatism, growth, and return on investment," Review of Accounting Studies, Springer, vol. 12(2), pages 325-370, September.
    2. Stephen Penman & Francesco Reggiani, 2013. "Returns to buying earnings and book value: accounting for growth and risk," Review of Accounting Studies, Springer, vol. 18(4), pages 1021-1049, December.

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