The current issue and full text archive of this journal is available at

www.emeraldinsight.com/0307-4358.htm

MF
37,4

The differential information

content of loss components under
a conservative accounting regime

316

Dimosthenis Hevas and Georgia Siougle

Department of Accounting and Finance,
Athens University of Economics and Business, Athens, Greece

Abstract
Purpose This study aims to test empirically the validity of the accounting valuation model that is
based on earnings and book values for loss-reporting firms under a conservative accounting regime.
Design/methodology/approach The empirical tests are performed by employing returns models
on data derived from non-financial firms listed on the Athens Stock Exchange for the period
1992-2000.
Findings The empirical results suggest that there is no unique concept of income, which is
applicable, for valuation purposes, in all circumstances. Total income may be the appropriate income
concept to use for the valuation of profit reporting firms but not for loss-reporting ones; for loss-reporting
firms, ordinary income appears to be a more useful concept for valuation purposes. Extraordinary
income was also found to be value relevant. Further, different versions of the accounting valuation
model appear to be more relevant for different groups of firms (groups defined in terms of various firm
characteristics, such as: size, growth opportunities and riskiness.
Practical implications The study examines the informational content of the various earnings and
loss items in the income statement and provides conclusions that are useful for standard setters,
accounting policy makers and market participants.
Originality/value It provides further evidence on the value relevance of losses, as opposed to that of
earnings. It coincides with the development of a new project initiated by the International Accounting
Standards Board, i.e. Reporting Comprehensive Income, concerning the content of the income
statement. The analysis is carried in an accounting environment that adopts only historic cost
accounting for the recording and measurement of assets and liabilities, revenues and expenses.
Keywords Stock exchanges, Financial reporting, Accountancy, Greece, Asset valuation
Paper type Research paper

Managerial Finance
Vol. 37 No. 4, 2011
pp. 316-333
q Emerald Group Publishing Limited
0307-4358
DOI 10.1108/03074351111115287

1. Introduction
In this paper, we examine the value relevance of various concepts of accounting losses,
reported in the income statement, under a conservative accounting regime. More
specifically: first, we test whether losses are valued differently than earnings by investors;
and, second, we disaggregate accounting income into its components and we test whether
this disaggregation improves the earnings (loss) returns relation. The loss components
whose value relevance is tested are the components that were identified in both theoretical
and empirical research as playing an important role in stock valuation, i.e. operating income
(OPt)[1], financial income (FINt), income from ordinary activities (ORDt), income from
extraordinary activities (EXT) and discontinued operations (EXTt) and total income (EPSt).
The authors would like to acknowledge Professor Dimitris Ghicas for useful comments.

The paper contributes in the existing literature in the following ways:

.
It provides further evidence on the value relevance of losses, as opposed to that of
earnings. The value relevance of losses is an issue that has not attracted yet much
interest among researchers in Europe (Martikainen et al., 1997, were the only
Europeans that examined the value relevance of losses in the Finnish Stock
Market).
.
It coincides with the development of a new project initiated by the
International Accounting Standards Board (IASB) concerning the content of
the income statement[2]. Some of the motivations of this project were: first, that the
various income items (such as operating and financing income) are incompletely
defined and second, that different entities use different measures of earnings. This
study examines the informational content of the various earnings and loss items in
the income statement and provides conclusions that may be useful for standard
setters and accounting policy makers.
.
It differs from other studies that examined the incremental informational
content of earnings components (Lipe, 1986; Giner and Reverte, 1998; Ballas,
1999) since they concentrated on earnings only while this study includes
loss-reporting firms.
.
The analysis is carried in an accounting environment that adopts only historic
cost accounting for the recording and measurement of assets and liabilities,
revenues and expenses. It is well known that under historic cost accounting
important information concerning changes in market values is concealed from the
users of the published financial statements. The most important information
that is hidden is the amount of the unrealized investment income and, therefore,
the reported investment income is misleading.
The study will be carried out by using data from the Athens Stock Exchange. Greece is
a code law country that adopts historic cost accounting for the recording, valuation
and (initial and subsequent) measurement of (both operating and financial) assets
and liabilities, income and expenses. Greek accounting system can be classified as a
conservative[3], [4]tax driven accounting system. Practically, it means that no
unrealized income is shown on both the interim and the annual accounts of the reporting
entities.
The main findings of this study suggest that the validity of the earnings-book
values capitalization model depends on the income concept employed. More specifically,
our empirical findings suggest that total income is value relevant for profit-reporting
firms but not for those reporting a loss; for the latter firms, it is earnings from ordinary
activities (ORD) that are value relevant. Decomposing further the income from ORD to
operating income and FIN does not improve the explanatory power of the earnings-book
values capitalization model. Extraordinary income is also value relevant although the
earnings response coefficient (ERC) of extraordinary income is statistically different
from that of ordinary income for both profit- and loss-reporting firms.
In Section 2 of the paper, we present a review of the existing literature. In Section 3,
we present the models that will be tested in this study. The data will be presented in
Section 4, while the empirical findings will be presented in Section 5. The paper
concludes with Section 6.

Loss components

317

MF
37,4

318

2. Review of the literature

Previous empirical research, using data from the USA, has shown that the explanatory
power of the simple earnings capitalization model weakens when both profit and loss
firms are included in the sample (Hayn, 1995; Collins et al., 1999). While reported profits
appear to be value relevant and positively associated with stocks prices/returns, because
they convey information useful in the prediction of future cash flows, reported losses are
either value irrelevant or negatively associated with stocks prices/returns.
Hayn (1995), estimated the simple earnings capitalization model (earnings defined
as those from continuing operations) using a sample of 85,919 firm-years over the
29-year period 1962-1990 which was partitioned into two sub-samples: one included all
profit reporting firms and the other included all loss-reporting firms. She reported that
the estimated ERCs of loss firms (and the corresponding coefficient of determination
R 2) is smaller than the ERC (and the R 2) of the full sample which in turn is smaller than
the ERC of the profit sample. Her findings suggested that losses are less informative
than profits about a firms future prospects. Her conclusions were that in the case
of loss-reporting firms, investors treat losses either as temporary in nature, in which
case they cannot transmit to the market participants something useful for valuation
purposes, or, as permanent, in which case the rational investor will consider the option of
liquidating his investment.
Collins et al. (1999), using a sample of 90,171 firm-years with positive book value over
the period 1975-1992 found also a negative relation between price (cum dividend) and
losses (defined as income available to common shareholders). They attributed their
findings to model mis-specification. When they allowed the beginning of period book
value to enter as an additional explanatory variable in the model, the ERC became either
positive and statistically significant or statistically insignificant, while the adjusted R 2
increased substantially. They suggested that book value is useful, first, as a value
relevant proxy for expected future abnormal earnings for loss firms and, second, as a
proxy for the liquidation value of the firm if investors choose to sell their investment in
the loss-reporting firm.
In Europe, Martikainen et al. (1997), using a sample of 39 Finish firms listed on the
Helsinki Stock Exchange during the period of 1974-1989, found that accounting losses
are not significantly related to stock returns in Finland. They also reported that adjusting
the reported earning and taking into consideration the recommendations of the Finish
Committee of Corporate Analysis did not improve the earnings-returns relation.
One problem with studies of this type is that there is not an agreement
among researchers as to which is the appropriate earnings (losses) concept to use in the
estimation of the earnings-returns and earnings-prices relation. The differences in the
results obtained could be attributed to the fact that different earnings (losses) concepts
were adopted by each study. The differences exist not only in empirical research but
also in the theoretical models. For example, according to Ohlson (1995), under clean
surplus accounting and if certain conditions are fulfilled it is the aggregate clean
surplus earnings that matter in the equity valuation process, i.e.:
P t a bxt gbvt

where Pt is the market value of the equity at period t, xt is the clean surplus accounting
income, bvt is the book value of equity, b is the ERC and g is the book value response
coefficient (BVRC).

If equation (1) holds then there is no practical benefit of disclosing the components of
clean surplus accounting income separately. In other words, if total clean surplus income is
disaggregated in any two (or more) components (such as x1t and x2t where x1t x2t xt)
and the researcher estimates equation (2) below:
P t a b1 x1t b2 x2t gbvt

instead of equation (1), he should find that b1 b2 b.

Brief and Peasnell (1996), however, argued that if non-recurring items are included in
the clean surplus income then the variability of the income series will increase and its
predictive ability will be reduced. Stark (1997) demonstrated that if the components of
the clean surplus earnings have additional predictive ability over their sum then their
separate disclosure will improve the predictive ability of earnings. Along these lines,
Ohlson (1999) presented a model in which core income (together with book values) is
value relevant, as long as transitory income is not autocorrellated.
Empirical evidence obtained by many researchers (Lipe, 1986; Ohlson and Penman,
1992; Fairfield et al., 1996; Ballas, 1999) suggested that earnings decomposition (into
financial, operating, extraordinary and similar types of income) increase the explanatory
power of equity valuation models although the findings of other researchers (Giner and
Reverte, 1998) produced quite the opposite results.
Therefore, it remains open to empirical research to prove the validity of the various
accounting valuation models proposed in the literature and this study will try to
contribute towards that.
3. The models
On the one hand, net income is a measure of the effective use of the total net assets by
management. On the other hand, net income includes the effect of non-recurring events
(such as extraordinary events and/or discontinued operations) upon net income. These
latter events may represent only a value irrelevant noise and thus introduce increased
volatility in the time series of net income and, therefore, reduce its usefulness for
valuation purposes.
Income from EXT and discontinued operations may be completely transitory in nature
and, therefore, value irrelevant, although the management may use it as
an income-smoothing device. On the contrary, the income from ORD is the income
from the continuing activities of the firm and, therefore, it represents the outcome
of the sustainable activities of the firm. Different degrees of accounting conservatism,
however, in the recognition, measurement and valuation of various assets may result in
different response coefficients, for each class of income. For example, a company may apply
historic cost accounting for operating assets and fair value accounting for financial assets. If
this is the case, the reported operating income will underestimate the changes in the market
values (especially in period of high inflation) while the FIN will not; the ERC for the income
from operating activities will be higher than that for the income from financing activities.
In order to examine the value relevance of various components of losses, we will make
use of the following model[5]:
Rt a

X
k

bk

PX kt X 0 LX kt
BV kt21

c
bk
P t21
P t21
P t21
k

Loss components

319

MF
37,4

320

where:
Rt

(Pt dt 2 Pt2 1)/Pt2 1.

Pt

the price six months after fiscal year end.

dt

the dividend distributed in year t.

Xkt

the per share value of earnings component k for year t.

PXkt

Xkt if Xkt . 0; 0 otherwise.

LXkt

Xkt if Xkt , 0; 0 otherwise.

BVt2 1 the beginning of fiscal year book value per common share.
bk

the ERC of income component k for profit-reporting firms.

bk0

the ERC of income component k for loss-reporting firms.

the BVRC.

In model (3) we assume, first, that the ERC sof profit firms is different from that of loss
firms and, second, that the ERCs of the various income components differ among each
other. Formally stated, we well test the validity of the following two hypotheses:
H1. The ERCs of profit-reporting firms is different from the ERC of loss-reporting
firm.
This hypothesis means that the estimated ERCs will differ between profit- and
loss-reporting firms:
H2. The ERCs of the various income components will vary among each other for
both profit- and loss-reporting firms.
This hypothesis means that if total income is disaggregated into its components, in the
earnings book value valuation model, the estimated ERCs will vary among each other.
The ERCs of income components that are of a more permanent nature will be higher from
the ERCs of income components that are of a more transitory nature and, therefore, more
volatile. Similarly, the ERCs of income components that are measured with a higher
degree of conservatism will be higher from the ERCs of income components that are
measured with a lower degree of conservatism[6].
In this paper, we will test the value relevance of the following income components
against each other:
EPSt

the earnings per share available to common shareholders.

ORDt

the income from ordinary activities per common share.

OPt

the income from operations per common share.

FINt

the FIN per common share.

EXTt

the extraordinary income per common share.

TAXt

the income tax per share (as it is calculated under the income tax payable
method)[7].

Loss components

The models that will be actually tested are, therefore, the following:
PEPS t
LEPS t
BV t21
b2
c1
I
P t21
P t21
P t21
PORDt
LORDt
PEXT t
LEXT t
TAX t
BV t21
b2
c1
c2
d
e
II
R t a b1
P t21
P t21
P t21
P t21
P t21
P t21
Rt a b1

R t a b1
e

POP t
LOP t
PFIN t
LFIN t
PEXT t
LEXT t
b2
c1
c2
d1
d2
P t21
P t21
P t21
P t21
P t21
P t21

III

TAX t
BV t21
f
P t21
P t21

where P stand for profit-reporting firms and L stands for loss-reporting firms.
In model (I), we assume that total net income available to common shareholders is the
value relevant variable that is used by the market in the evaluation of stocks. In models
(II) and (III), we relax this assumption and assume that each income component is valued
differently by the market. More specifically:
.
In model (II), we assume that it is not total income that is value relevant. Investors
differentiate between income from ORD (i.e. the income originating from the
permanent activities of the firm) and the income from EXT (which are of a more
transitory nature). We expect that the ERC of the extraordinary income will be less
from that of the ordinary income because the former will be more volatile.
.
In model (III), we disaggregate, further, ordinary income to operating income and
FIN. The reason for this disaggregation is twofold: first, reported FIN under the
cost method under (over)estimates total FIN and thus the estimated ERC of the
FIN will be over (under)estimated; and, second, there are some evidence that FIN is
used by the reporting entities as an income-smoothing device and that it should
be priced differently from operating income (Warfield and Linsmeier, 1992). For
these reasons, no a priori expectations about the sign and the size of the ERCs of
FIN are formed.
4. The data
The data were obtained from the Statistical Department of the Athens Stock Exchange
and cover all non-financial sector firms for which data were available for the period
1992-2000. We identified 79 non-financial firms for which all relevant data were
available for the nine-years period. This gave us a total of 711 reporting firm years.
In Table I, we present the distribution of positive and negative values of the earnings
components for each of the years that this study covers.
From the figures listed on Table I, we notice that there were 118 firm years in which
the earnings per share (EPS) were negative; this number is reduced to 110 for the income
from ORD and 111 for the income from operations (OP), respectively. Most of the
companies in our sample, however, report negative income from EXT as well as FIN.
This latter finding can be attributed to two factors, first, that Greek companies rely
heavily to bank capital as a major source of debt capital, which means that the interest
expense constitutes a major expense item in most income statements; and, second,
as income from investment on securities is recorded only that realized from either

321

MF
37,4

Year

EPSt

ORDt

OPt

FINt

EXTt

322

1992
1993
1994
1995
1996
1997
1998
1999
2000
Total

14
18
12
10
9
12
14
13
16
118

12
15
17
8
7
10
12
12
17
110

8
10
9
9
9
10
16
20
20
111

50
57
49
48
51
49
52
41
39
436

56
59
55
60
48
54
50
62
52
496

Table I.
Distribution of negative
earnings by year

Notes: Variables definition: EPSt the earnings per share available to common shareholders; ORDt
the income from ordinary activities per common share; OPt the income from operations per common
share; FINt the financial income per common share; EXTt the extraordinary income per common
share

dividends distributions or sale of securities and, therefore, the recorded investment

income does not reflect the underlying changes in the market values of stocks held for
either trading or investment purposes.
In Table II, we present the distribution of years with losses for the 79 firms in our
sample.
From the figures listed on Table II, we notice that from the 79 firms in our sample,
41 firms reported only positive EPS for the whole nine-years period that this study
covers; 11 of them reported negative EPS only once in the nine-years period; five of them
reported negative EPS for two years and 22 of them reported negative EPS for three or
more years. A similar distribution appears to exist for both the ORD and the OP
variables. With respect to the FIN variable, we notice that only 14 firms never reported
negative FIN while 59 firms reported negative FIN for three or more years.
Extraordinary income is almost always negative for three or more years while only three
firms never reported negative extraordinary income.
In Table III, we present the distribution of loss firm years according to firms size,
firms growth opportunities and firms riskiness.
Size is defined in terms of total assets. The firm years in our sample are split into two
equal groups, i.e. small and large, according to the median value of their total assets;
No. of loss years
0
1
2
3 or more
Total
Table II.
Distribution of firms
by the number of years
with losses

EPSt

ORDt

OPt

FINt

EXTt

41
11
5
22
79

43
10
4
22
79

45
10
9
15
79

14
2
4
59
79

3
1
3
72
79

Notes: Variables definition: EPSt the earnings per share available to common shareholders; ORDt
the income from ordinary activities per common share; OPt the income from operations per common
share; FINt the financial income per common share; EXTt the extraordinary income per common
share

Large
35
9.8
OPt
Non-growth
41
15.8

OPt

OPt
More risky Less risky
57
54
16.0
15.0

Growth
70
15.4

Small
76
21.3

Large
158
44.0
FINt
Non-growth
152
58.9

FINt

FINt
More risky Less risky
216
220
60.6
61.7

Growth
284
62.6

Small
278
78.0

Large
197
55.3
EXTt
Non-growth
176
68.2

EXTt

EXTt
More risky Less risky
248
248
69.6
69.6

Growth
320
70.6

Small
299
83.9

Notes: Variables definition: EPSt the earnings per share available to common shareholders; ORDt the income from ordinary activities per common
share; OPt the income from operations per common share; FINt the financial income per common share; EXTt the extraordinary income per
common share

Panel A distribution of losses by size

EPSt
ORDt
Years
Small
Large
Small
Large
Negative
99
19
77
33
Percentage
27.0
5.3
21.6
9.2
Panel B distribution of losses by growth opportunities
EPSt
ORDt
Years
Growth
Non-growth
Growth
Non-growth
Negative
77
41
69
41
Percentage
16.9
15.8
15.2
15.8
Panel C distribution of losses by firms riskiness
EPSt
ORDt
Years
More risky Less risky More risky Less risky
Negative
57
61
49
61
Percentage
16.0
17.0
13.7
17.1

Loss components

323

Table III.
The distribution of losses
by certain firms
characteristics

MF
37,4

324

as small are defined those whose total assets are below the median while as large
are defined those whose total assets are above the median. From the figures listed on
panel A of Table III, we notice that there is a concentration of negative results to those
firms classified as small. The EPS variable, for example, took a negative value for the
27 per cent of the small firms; the respective figure for the large firms was 5.30 per cent.
Growth opportunities are defined in terms of the change in net fixed assets. A positive
change in net fixed assets implies the existence of growth opportunities (here and after
growth firms) while a negative change in net fixed assets implies the absence of growth
opportunities (here and after non-growth firms). From the 711 firm years in our sample,
453 were classified as offering growth opportunities while 258 were classified as
non-offering growth opportunities. From the figures listed on panel B of Table III, we
notice that the percentage of firms that reported negative income items is distributed
almost equally among growth and non-growth firms.
Riskiness is defined in terms of the debt to equity ratio. The firm years in our sample
are split into two equal groups, i.e. to more risky and less risky, according to the median
value of their debt to equity ratio; as less risky are defined those firms whose debt to
equity ratio is below the median while as more risky are defined those whose debt to
equity ratio is above the median. From the figures listed on panel C of Table III, we notice
that for the ORD variable there is a concentration of negative results to the less risky
firms; this is not the case, however, for the other income items which appear to be
distributed evenly among the more risky and the less risky firms.
In Table IV, we present univariate statistics for the variables included in models
(I)-(III).

Rt
PEXTt
LEXTt
PORDt
LORDt
PEPSt
LEPSt
PFINt
LFINt
POPt
LOPt
TAXES
BVt2 1

Table IV.
Descriptive statistics

Minimum

Maximum

Median

Mean

SD

0.000019
0
20.003570
0
20.000812
0
20.000853
0
20.002569
0
20.000577
20.002925
0.000004

0.195820
0.001516
0
0.015796
0
0.012732
0
0.003343
0
0.013679
0
0
0.065232

0.003478
0
20.000002
0.000066
0
0.000054
0
0
20.000005
0.000081
0
20.000034
0.001473

0.009183
0.000014
20.000058
0.000362
0.000021
0.000319
20.000022
0.000077
20.000095
0.000375
20.000015
20.000079
0.003044

0.000661
0.000002
0.000008
0.000035
0.000003
0.000031
0.000003
0.000011
0.000008
0.000033
0.000002
0.000178
0.005145

Notes: n 711; variables definition: Pt the price six months after fiscal year end; dt the dividend
distributed in year t; Rt (Pt dt Pt2 1)/Pt; EPSt the earnings per share available to common
shareholders; PEPSt EPSt if EPSt . 0; 0 otherwise; LEPSt EPSt if EPSt ,0; 0 otherwise; ORDt
the income from ordinary activities per common share; PORDt ORDt if ORDt . 0; 0 otherwise;
LORDt ORDt if ORDt , 0; 0 otherwise; OPt the income from operations per common share; POPt
OPt if OPt .0; 0 otherwise; LOPt OPt if OPt , 0; 0 otherwise; FINt the financial income per
common share; PFINt FINt if FINt . 0; 0 otherwise; LFINt FINt if FINt , 0; 0 otherwise; EXTt
the extraordinary income per common share; PEXTt EXTt if EXTt .0; 0 otherwise; LEXTt EXTt
if EXTt ,0; 0 otherwise; and BVt2 1 the beginning of fiscal year book value per common share; all
variables but Rt were deflated with Pt2 1

From the figures listed on Table IV, we notice that in many cases, the mean values of the
variables deviate substantially from their median values suggesting that the means
have been influenced by outlying observations. We excluded as outliers all those
observations for which the distance between the fitted regression value and the actual
value was greater than three standard deviations.
5. The empirical results
Table V contains univariate parametric correlation coefficients among the different
variables used in this study.
From the figures listed on Table V, we observe that Rt is highly correlated with all
independent variables. Moderate correlation coefficients are also observed among the
various independent variables of our study. These results indicate the existence of
collinearity among certain independent variables. For this reason, the condition index
suggested by Belsley et al. (1980) was calculated for each equation in order to examine
the presence of multicollinearity. The values obtained are very low suggesting that the
absence of multicollinearity. We also correct for heteroscedasticity using Whites (1980)
heteroscedasticity-consistent covariance matrix.
Table VI presents the empirical results of estimating models (I)-(III)[8].
From the figures listed on Table VI for model (I), we notice that the PEPSt variable is
statistically significant and with a positive sign at a 0.01, as expected and the LEPSt
variable is statistically insignificant. This finding is consistent with that obtained by
Collins et al. (1999). It appears that for loss-reporting firms total income available to
common shareholders is value irrelevant; it is only book value that matters in the
valuation process.
In model (II), we relax the assumption that the market values earnings as a composite
number; rather, we assume that each earnings component is valued differently by
investors. From the figures listed on Table VI for model (II), we notice that earnings
(losses) decomposition to ordinary and extraordinary earnings improves the
explanatory power of the valuation model from 0.818 to 0.838. The two earnings
variables for profit reporting firms, i.e. the PORDt and PEXTt variables, have the
expected positive sign and are statistically significant at a 0.01 and a 0.05 levels,
respectively. The LORDt variable is negatively associated with stock returns and
statistically significant at a 0.01, while the LEXTt variable is positively associated
with stock returns and statistically significant at a 0.01. The results obtained from
estimating model (II), compared with those obtained from model (I) suggest that for
loss-reporting firms, the losses from ORD (i.e. the losses from the permanent activities of
the firm) is a superior measure of firms performance than aggregate losses. The positive
sign that was obtained for the LEXTt variable may imply that investors consider it as an
item manageable by the individual firms.
In model (III), we relax the assumption that the market values the ordinary earnings as
a composite whole; rather, we disaggregate the earnings (losses) from ORD to those
originating form the operating activities of the firm (OP) and those originating from the
financing activities of the firm (FIN) and we assume that each earnings component is
valued differently by investors. From the figures listed on Table VI for model (III), we
notice that this decomposition reduces the explanatory power of the valuation model, from
0.818 (for model I) and 0.838 (for model II) to 0.806. In model (III), all the earnings variables
for profit reporting firms behave as expected. For the loss-reporting firms, however,

Loss components

325

Table V.
Correlation coefficients
PORDt

LORDt

PEPSt

LEPSt

PFINt

LFINt

POPt

LOPt

1.000

TAXESt BVt2 1

1.000
20.360 * 1.000
0.228 * 0.098 * *
1.000
20.210 * 0.974 *
0.085 * *
1.000
0.373 * 0.087 * *
0.867 *
0.083 * *
1.000
0.046
0.043
0.028
0.053
0.035
1.000
0.132 * 2.009
0.115 *
0.009
0.081 * *
0.186 *
1.000
20.227 * 0.137 * 2 0.003
0.104 *
0.004
2 0.127 * 2 0.635 *
1.000
20.035
0.042
0.075
0.042
0.072
2 0.011
0.176 *
0.181 * 1.000
0.291 * 2.937 * 2 0.076
20.932 * 20.061
2 0.531 *
0.091 * * 20.797 * 2.069
1.000
20.165 * 0.212 * 2 0.045
0.200 * 20.052
0.193 * * 2 .237 *
0.230 * 2.010 2 0.164 *

LEXTt

dividend distributed in year t; Rt (Pt dt Pt2 1)/Pt; EPSt the earnings per share available to common shareholders; PEPSt EPSt if EPSt . 0; 0
otherwise; LEPSt EPSt if EPSt , 0; 0 otherwise; ORDt the income from ordinary activities per common share; PORDt ORDt if ORDt . 0; 0 otherwise;
LORDt ORDt if ORDt ,0; 0 otherwise; OPt the income from operations per common share; POPt OPt if OPt .0; 0 otherwise; LOPt OPt if OPt , 0;
0 otherwise; FINt the financial income per common share; PFINt FINt if FINt . 0; 0 otherwise; LFINt FINt if FINt , 0; 0 otherwise; EXTt the
extraordinary income per common share; PEXTt EXTt if EXTt . 0; 0 otherwise; LEXTt EXTt if EXTt ,0; 0 otherwise; and BVt2 1 the beginning of
fiscal year book value per common share; all variables but Rt were deflated with Pt2 1

Notes: n 711; significance at: *a 0.01, * *a 0.05 (two-tailed test); variables definition: Pt the price six months after fiscal year end; dt the

1.000
0.210 * *
1.000
20.228 * *
0.072
0.653 * *
0.057
20.110 * * 2 0.418 *
0.666 * *
0.159 *
20.081 * 2 0.035
0.063
0.008
20.037
2 0.092 * *
0.042
0.056
20.013
0.027
20.802 *
0.027
0.287 *
0.030

PEXTt

326

Rt
PEXTt
LEXTt
PORDt
LORDt
PEPSt
LEPSt
PFINt
LFINt
POPt
LOPt
TAXES
BVt2 1

Rt

MF
37,4

Variables
Constant
PEPSt
LEPSt
PORD
LORDt
POPt
LOPt
PFINt
LFINt
PEXTt
LEXTt
TAXES
BV
Adjusted R 2
Wald test
ERCPEPS ERCLEPS
ERCPORD ERCLORD
ERCPOP ERCLOP
ERCPFIN ERCLFIN
ERCPEXT ERCLEXT
ERCPORD ERCPEXT
ERCLORD ERCLEXT
ERCPOP ERCPFIN ERCPEXT
ERCLOP ERCLFIN ERCLEXT

Model I
0.410 (3.963) *
7.862 (2.983) *
2 0.265 (20.880)

0.369 (5.478) *
0.818

Model II
0.378 (3.887) *
8.855 (1.270) *
2 1.233 (23.770) *

3.014 (2.0253) * *
2.684 (2.604) *
2 3.192 (21.795) * * *
0.334 (5.209) *
0.838

Model III

Loss components

0.327 (2.712) *

5.310 (5.340) *
22.347 (2 2.990) *
7.614 (9.205) *
4.439 (3.642) *
4.365 (1.939) * *
20.894 (2 0.542)
23.386 (2 1.735) * * *
0.377 (3.554) *
0.806

327

4.787 * *
1.721 *
8.233 *
15.353 *
9.060 *

1.185 *
0.001
1.200 *
1.786
8.509 *

Notes: Significance at: *a 0.01, * *a 0.05, * * *a 0.10 (two-tailed test);variables definition: Pt

the price six months after fiscal year end; dt the dividend distributed in year t; Rt (Pt dt Pt2 1)/
Pt; EPSt the earnings per share available to common shareholders; PEPSt EPSt if EPSt . 0; 0
otherwise; LEPSt EPSt if EPSt ,0; 0 otherwise; ORDt the income from ordinary activities per
common share; PORDt ORDt if ORDt . 0; 0 otherwise; LORDt ORDt if ORDt ,0; 0 otherwise; OPt
the income from operations per common share; POPt OPt if OPt . 0; 0 otherwise; LOPt OPt if OPt
,0; 0 otherwise; FINt the financial income per common share; PFINt FINt if FINt .0; 0 otherwise;
LFINt FINt if FINt ,0; 0 otherwise; EXTt the extraordinary income per common share; PEXTt
EXTt if EXTt . 0; 0 otherwise; LEXTt EXTt if EXTt ,0; 0 otherwise; and BVt2 1 the beginning of
fiscal year book value per common share; all variables but Rt were deflated with Pt2 1

only the LOPt variable, has the expected negative sign and is significant at a 0.01; the
LFINt variable is positively associated with stock returns and statistically significant at
a 0.01, while the LEXTt variable is statistically insignificant. The positive sign obtained
for the LFINt variable may be attributed to the cost method that is adopted by the Greek
accounting legislation in reporting the income from investments. As it is known, according
to this method, income is recorded only when a dividend distribution occurs and, therefore,
investors may consider the recorded FIN as a sub-estimation of the true FIN of the firm. On
aggregate, however, the valuation model described by equation (III) is not superior to that
described by either equations (I) or (II)[9].
We also performed Wald tests of equality between the estimated ERCs (the results are
shown on the bottom of Table VI). In most cases the null hypotheses (i.e. that the
estimated ERCs are equal among each other) was rejected. These findings give further
support to both of our hypotheses, i.e. that the ERCs of profit-reporting firms differ from

Table VI.
Regression results for the
various accounting
valuation models

MF
37,4

328

those of loss-reporting firms and, secondly, that different income items have different
degrees of value relevance.
In Table VII, we split the sample into two sub-groups, according to the size of the total
assets and we test the validity of our results for small and large firms. The implicit
assumption is that earnings (losses) and their components are more informative for large
than for small firms.
From the evidence in Table VII, we notice that the explanatory power of all three
valuation models is reduced when firms are split into small and large firms. It appears,
however, that when firms are grouped according to size, model (III) performs better than
either model (I) or (II). Comparing the results presented in Table VII with those presented
in Table VI for model (I) we notice that, with the exception of the FIN variable, for small
loss-reporting firms, all other loss variables are value irrelevant. The TAXt variable is
statistically significant and with a negative sign, only in model (III) at a 0.10 for large
firms and at a 0.05 for small firms.
As it is well known from the literature, conservative accounting combined with an
increase in investment will result in a reduction of current profits which, however, are
expected to sustain an increase in future earnings. In Table VIII, we split the sample into
two sub-groups, growth and non-growth firms. We assume that for non-growth firms
earnings (losses) will be less value -relevant than for growth firms.
From the results listed in Table VIII, we notice the explanatory power of models
(I)-(III) for non-growth firms is higher than that for the total sample (reported on Table VI);
model (II), however, exhibits the highest explanatory power. More specifically:
.
In model (I), the LEPSt variable is significant at a 0.05 only for non-growth firms.
.
In model (II), both the LORDt and LEXTt variables are significant at a 0.10
and a 0.05 only for non-growth firms.
.
In model (III), both the LOPt and the LFINt variables are statistically significant
at a 0.01 for growth firms but not for non-growth firms. In the latter sample,
none of the loss variables is statistically significant.
In Table IX, we split the sample into two sub-groups, i.e. more risky and less risky firms.
As more risky firms, we define all those firms whose debt to equity ratio is greater than the
median debt to equity ratio of the firms in our sample; as less risky firms, we define all those
firms whose debt to equity ratio is smaller than the median debt to equity ratio of the firms
in our sample. We expect that earnings will be more informative for the more risky firms.
From the figures listed in Table IX, we notice that the explanatory power of all three
valuation models is reduced when firms are split into two groups according to their
financial risk. For loss-reporting firms that are classified as more risky, none of the
LEPSt, LORDt and LOPt variables is statistically significant. The LFINt variable is
statistically significant for both groups (see model (II)) while the LEXTt variable is
statistically significant at a 0.01, in both models (II) and (III) only for the risky group.
6. Conclusions
In this paper, we tested the validity of the accounting valuation model that is based on
earnings and book values for loss-reporting firms using data from the Athens Stock
Exchange for the period 1992-2000. In the empirical tests, we employed returns models
and corrected for heteroscedasticity using Whites (1980) heteroscedastisity consistent
covariance matrix. The empirical results suggest that:

1.190 (9.389) *
0.693
2.629 *

2.094 (3.442) *
0.606
0.565

Small
0.430 (2.551) *
4.715 (5.855) *
20.025 (20.019)

Model I
0.267 (0.450)
2.887 (0.810)
1.452 (1.075)

Large

3.701 * *
0.475

0.062
3.592 * *

0.909
1.493
0.895

Model III

(20.900)
(1.117)
(0.967)
(20.522)
(2.517) *
(21.003)
(21.843) * * *
(3.221) *

0.158 (0.276)

Large

2 6.401
2.087
3.263
2 3.504
4.284 (1.889) * * *
1.813 (0.869)
4.906
22.400 (20.242) 2 0.690 (20.288) 2 1.478
27.266 (21.002) 2 3.467 (21.485) 2 1.535
2.048 (3.166) *
1.088 (1.034) *
2.126
0.604
0.702
0.614

3.719 (3.404) *
2 0.695 (20.489)

20.003 (20.001)
1.484 (1.133)

Small
0.381 (2.338) *

Model II
0.154 (0.280)

Large

(2.442) *
(21.142)
(2.921) *
(2.797) *
(1.334)
(20.499)
(22.242) * *
(9.663) *

4.206 * *
4.713 * *
3.808 * *

2.705
2 2.678
3.492
3.819
3.050
2 1.037
2 5.436
1.083
0.705

0.411 (2.579) *

Small

Notes: Significance at: *a 0.01, * *a 0.05, and * * *a 0.10 (two-tailed test); variables definition: Pt the price six months after fiscal year end; dt
the dividend distributed in year t; Rt (Pt dt Pt2 1)/Pt; EPSt the earnings per share available to common shareholders; PEPSt EPSt if EPSt . 0; 0
otherwise; LEPSt EPSt if EPSt , 0; 0 otherwise; ORDt the income from ordinary activities per common share; PORDt ORDt if ORDt . 0; 0 otherwise;
LORDt ORDt if ORDt ,0; 0 otherwise; OPt the income from operations per common share; POPt OPt if OPt .0; 0 otherwise; LOPt OPt if OPt , 0;
0 otherwise; FINt the financial income per common share; PFINt FINt if FINt . 0; 0 otherwise; LFINt FINt if FINt , 0; 0 otherwise; EXTt the
extraordinary income per common share; PEXTt EXTt if EXTt . 0; 0 otherwise; LEXTt EXTt if EXTt ,0; 0 otherwise; and BVt2 1 the beginning of
fiscal year book value per common share; all variables but Rt were deflated with Pt2 1

Constant
PEPSt
LEPSt
PORDt
LORDt
POPt
LOPt
PFINt
LFINt
PEXTt
LEXTt
TAXES
BV
Adjusted R 2
Wald test
ERCPEPS ERCLEPS
ERCPORD ERCLORD
ERCPOP ERCLOP
ERCPFIN ERCLFIN
ERCPEXT ERCLEXT

Variables

Loss components

329

Table VII.
Regression results for the
various accounting
valuation models firm
years grouped by size

Table VIII.
Regression results for the
various accounting
valuation models firm
years grouped by growth
opportunities
Non-growth

0.632 (7.387) *
0.898
6.154 *

1.163 (6.245) *
0.780
5.479 *

0.268 (1.553)
0.115 (0.861)
5.917 (7.258) *
7.866 (1.285) *
21.319 (20.576) 21.790 (22.271) * *

Model I
Non-growth

5.557 *
1.671

(2.377) *
(2.226) * *
(1.614) * * *
(6.479) *

3.976 * *

1.231
4.875
3.836
0.587
0.895

3.663 * *

4.012 (1.356)
20.423 (20.155)
23.068 (21.337)
1.070 (5.944) *
0.782

4.777 (4.234) *
9.199 (7.288)
21.747 (20.590) 21.527 (21.749) * * *

0.122 (0.962)

Model II
0.227 (1.477)

Growth

Model III

(4.943) *
(22.347) *
(3.512) *
(2.848) *
(0.814)
(0.731)
(21.753) * * *
(5.508) *

2.278 *
2.036
7.466 *

4.751
29.564
4.867
3.937
2.435
1.558
23.700
1.034
0.794

0.220 (1.581)

Growth

2.473
4.709 * *
3.392 * * *

3.519 (1.622) * * *
20.543 (20.322)
6.944 (7.419) *
2.644 (1.151)
1.169 (1.947) * *
0.130 (0.039)
25.497 (21.590)
0.615 (5.824) *
0.892

0.101 (0.732)

Non-growth

Notes: Significance at: *a 0.01, * *a 0.05, and * * *a 0.10 (two-tailed test); variables definition: Pt the price six months after fiscal year end; dt
the dividend distributed in year t; Rt (Pt dt Pt2 1)/Pt; EPSt the earnings per share available to common shareholders; PEPSt EPSt if EPSt . 0; 0
otherwise; LEPSt EPSt if EPSt , 0; 0 otherwise; ORDt the income from ordinary activities per common share; PORDt ORDt if ORDt . 0; 0 otherwise;
LORDt ORDt if ORDt ,0; 0 otherwise; OPt the income from operations per common share; POPt OPt if OPt .0; 0 otherwise; LOPt OPt if OPt , 0;
0 otherwise; FINt the financial income per common share; PFINt FINt if FINt . 0; 0 otherwise; LFINt FINt if FINt , 0; 0 otherwise; EXTt the
extraordinary income per common share; PEXTt EXTt if EXTt . 0; 0 otherwise; LEXTt EXTt if EXTt ,0; 0 otherwise; and BVt2 1 the beginning of
fiscal year book value per common share; all variables but Rt were deflated with Pt2 1

Constant
PEPSt
LEPSt
PORDt
LORDt
POPt
LOPt
PFINt
LFINt
PEXTt
LEXTt
TAXES
BV
Adjusted R 2
Wald test
ERCPEPS ERCLEPS
ERCPORD ERCLORD
ERCPOP ERCLOP
ERCPFIN ERCLFIN
ERCPEXT ERCLEXT

Growth

330

Variables

MF
37,4

1.026 (8.226) *
0.779
3.860 *

1.136 (5.391) *
0.702
8.890 *

0.215 (0.972)
0.576 (3.360) *
3.826 (3.160) *
5.428 (7.128) *
1.553 (1.547) 2 1.100 (20.588)

Model I
Risky
Less risky

6.006 *
0.806

7.870 *
1.081

5.458
26.253
25.724
0.947
0.735

4.994 (4.001) *
2 1.290 (20.580)

1.956 (1.408)
1.541 (1.553))

Model III

1.508
8.801 *
3.857 * *

(1.387)
(2 1.533)
(1.139)
(1.807) * * *
(1.609) * * *
(2 2.526) *
(2 2.541) *
(4.401) *

0.161 (0.850)

Risky

1.730
23.164
2.312
3.148
(1.065)
3.674 (1.059)
8.044
(2 2.416) *
4.758 (1.490)
25.688
(2 2.090) * * 2 1.314 (20.568) 26.467
(5.045) *
1.028 (8.257) *
0.954
0.775
0.738

0.573 (3.363) *

Less risky

0.181 (0.951)

Model II
Risky

(2.247) * *
(20.792)
(3.924) *
(1.712) * * *
(1.458)
(0.973)
(20.851)
(7.710) *

3.728 * *
0.073
3.555 * * *

4.186
2 2.256
4.829
3.350
5.015
3.776
2 2.520
0.993
0.775

0.582 (3.474) *

Less risky

Notes: Significance at: *a 0.01, * *a 0.05, and * * *a 0.10 (two-tailed test); variables definition: Pt the price six months after fiscal year end; dt
the dividend distributed in year t; Rt (Pt dt Pt2 1)/Pt; EPSt the earnings per share available to common shareholders; PEPSt EPSt if EPSt . 0; 0
otherwise; LEPSt EPSt if EPSt , 0; 0 otherwise; ORDt the income from ordinary activities per common share; PORDt ORDt if ORDt . 0; 0 otherwise;
LORDt ORDt if ORDt ,0; 0 otherwise; OPt the income from operations per common share; POPt OPt if OPt .0; 0 otherwise; LOPt OPt if OPt , 0;
0 otherwise; FINt the financial income per common share; PFINt FINt if FINt . 0; 0 otherwise; LFINt FINt if FINt , 0; 0 otherwise; EXTt the
extraordinary income per common share; PEXTt EXTt if EXTt . 0; 0 otherwise; LEXTt EXTt if EXTt ,0; 0 otherwise; and BVt2 1, the beginning of
fiscal year book value per common share; all variables but Rt were deflated with Pt2 1

Constant
PEPSt
LEPSt
PORDt
LORDt
POP t
LOP t
PFINt
LFINt
PEXTt
LEXTt
TAXES
BV
Adjusted R 2
Wald test
ERCPEPS ERCLEPS
ERCPORD ERCLORD
ERCPOP ERCLOP
ERCPFIN ERCLFIN
ERCPEXT ERCLEXT

Variables

Loss components

331

Table IX.
Regression results for the
various accounting
valuation models firm
years grouped by debt to
equity ratio

MF
37,4

332
.

For loss-reporting firms, the ERC of total losses, ordinary losses and operating
losses is either negative or statistically insignificant.
For the total sample, income from ORD appears to me more value relevant for
loss-reporting firms than either total income or operating income.
Different concepts of the accounting valuation model may be more value relevant
for different groups of firms (groups defined in terms of various firm
characteristics, such as: size, growth opportunities and riskiness).
Extraordinary income is value relevant although its ERC differs from that of the
other income components. Reporting extraordinary income separately in the
income statement, therefore, provides the users of the accounts with information
useful for valuation purposes.

For standard setters, the results of this study suggest that under conservative accounting,
the ERCs of the various income components are not the same. More conservative
accounting practices will result in the estimation of higher ERCs for the respective income
components. Furthermore, reporting different income components in the income statement
is not a waste. The published income statement must be very analytical since different
income concepts are applied in the valuation of firms with different financial characteristics.
Notes
1. This concept of income has been used extensively in empirical research (Penman and Zhang,
2002).
2. The title of the project is Reporting Comprehensive Income. For more information
concerning this project, look at the site of IASB at the following address: www.iasb.org.uk
3. For a review of the definition of conservatism in accounting, see Watts (2003).
4. Greek accounting legislation requires that reporting entities should report only realised
(from transactions) income but at the same time they should anticipate all losses.
5. These models were also used by Martikainen et al. (1997); they are analogous to the models
used by Collins et al. (1999).
6. Assume, for example, that the income that is value relevant is X and that the true ERC is a.
If, because of conservatism in accounting, the reported income equals kX (where 0 , k , 1),
the rational well-informed investor will use, for valuation purposes, X and not kX. The
researcher who will try to estimate the earnings-returns relation using reported income (i.e. kX)
instead of the true income (i.e. X) will obtain an ERC equal to b that will satisfy the following
relation a bk; since 0 , k , 1, for this relation to hold, b should be greater than a. In other
words, the more conservatism is applied in the measurement of a certain income item, the
higher the estimated ERC for that particular income item will be.
7. In Greece, corporate income tax is recorded according to the tax payable method.
8. The results presented in Tables VI-IX were obtained using yearly dummies. Contrary to
other studies (Martikainen et al., 1997), the inclusion of the yearly dummies improved
drastically the explanatory power of all three models.
9. In order to investigate further, the value relevance of the FIN variable we disaggregated it into
income from securities (SGL) and other financial income (OFIN) and we re-estimated model III.
This disaggregation did not improve the explanatory power of the valuation model. We also
carried a Wald test to test the equality between the estimated ERCs of the SGL and the OFIN
variables and the null hypotheses was accepted.

References
Ballas, A. (1999), Valuation implications of exceptional and extraordinary items, British
Accounting Review, Vol. 31 No. 3, pp. 281-95.
Belsley, D., Kuh, E. and Welsch, R. (1980), Regression Diagnostics: Identifying Influential Data
and Sources of Collinearity, Wiley, New York, NY.
Brief, R.P. and Peasnell, K.V. (1996), Clean Surplus: A Link between Accounting and Finance,
Garland, New York, NY.
Collins, D.W., Pincus, M. and Xie, H. (1999), Equity valuation and negative earnings: the role of
book value of equity, The Accounting Review, Vol. 74 No. 1, pp. 29-61.
Fairfield, P.M., Sweeney, R.J. and Yohn, T.L. (1996), Accounting classification and the predictive
content of earnings, The Accounting Review, Vol. 71 No. 3, pp. 337-55.
Giner, B. and Reverte, C. (1998), The value relevance of the earnings decomposition for the
Spanish Stock Market, paper presented in the 21st Annual Congress of the European
Accounting Association, Antwerp.
Hayn, C. (1995), The information content of losses, Journal of Accounting and Economics,
Vol. 20 No. 2, pp. 125-54.
Lipe, R. (1986), The information content of the components of earnings, Journal of Accounting
Research, Vol. 24, pp. 37-64 (Supplement).
Martikainen, T., Kallunki, J.P. and Perttunen, J. (1997), Finish eranings response coefficients: the
information content of losses, European Accounting Review, Vol. 6 No. 1, pp. 69-81.
Ohlson, J.A. (1995), Equity, book values and dividends in equity valuation, Contemporary
Accounting Research, Vol. 11 No. 2, pp. 661-87.
Ohlson, J.A. (1999), On transitory earnings, Review of Accounting Studies, Vol. 4, pp. 145-62.
Ohlson, J.A. and Penman, S.H. (1992), Disaggregated accounting data as explanatory variables
for returns, Journal of Accounting, Auditing and Finance, Vol. 7, Fall, pp. 553-75.
Penman, S.H. and Zhang, X. (2002), Accounting conservatism, the quality of earnings, and stock
returns, The Accounting Review, Vol. 77 No. 2, pp. 237-64.
Stark, A.W. (1997), Linear information dynamics, dividend irrelevance, corporate valuation and
the clean surplus relationship, Accounting & Business Research, Vol. 27 No. 3, pp. 219-28.
Warfield, T.D. and Linsmeier, T.J. (1992), Tax planning, earnings management, and the
differential information content of bank earnings components, Accounting Review, Vol. 67
No. 3, pp. 546-62.
Watts, R.L. (2003), Conservatism in accounting Part I: explanations and implications,
Accounting Horizons, Vol. 17 No. 3, pp. 207-21.
White, H. (1980), A heteroscedastic consistent covariance matrix and a direct test for
heteroscedasticity, Econometrica, Vol. 48, pp. 721-46.
Corresponding author
Dimosthenis Hevas can be contacted at: hevas@aueb.gr

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com

Or visit our web site for further details: www.emeraldinsight.com/reprints

Loss components

333