Principal Topic

This research study increases our understanding of the usefulness of accounting performance measures for start up and early growth firms. Results from prior research imply that earnings are more value-relevant than cash flows. However, Bernard (1989) implies that a firm’s life-cycle stage could affect the value-relevance of financial statement components. Firm value is composed of assets in place and growth opportunities. In early life-cycle stages, growth opportunities are a relatively larger component of firm value than assets in place. Thus, in these stages, the component that provides more value-relevant information about firm-value is the one that is most closely related to future growth opportunities.

Method

Accounting performance measures are examined in early firm life-cycle stages, and compared to mature firms, to determine which measure provides value relevant information. Ordinary least squares regressions of valuation models is used to investigate the incremental information provided by different financial statement components. In addition, these measures are compared using a Wald test to determine which variable provides the most information in start up, growth and mature portfolios of firms. Data are obtained from annual reports, Compustat and CRSP databases, and Moody’s.

Results and Implications

Results indicate that earnings do not provide significant valuation information for start-ups, but earnings become informative as firms move into a growth stage. Cash flow components are more value-relevant than earnings in these early stages of a firm’s existence. These results have implications for researchers, analysts, and management. If researchers assume these components are equally value-relevant across firm life cycle stages results will be weaker, and may lead to inaccurate conclusions. Analysts need to be aware of the changing value-relevance of these components and other measures throughout the life cycle, especially for new ventures. Also, firm management need not focus, nor be evaluated, on earnings as the most value-relevant accounting number in all life cycle stages of the firm.

CONTACT: Ervin L. Black, 540 TNRB, Marriott School of Management, Brigham Young University, Provo, UT 84602; (T) 801-378-1767; (F) 801-378-5933; erv_black@byu.edu