An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Yoshie Saito
Temple University

Abstract: I examine whether an informativeness-to-noise ratio can predict the impact of two sources of uncertainty, (1) limited prior information about firms and (2) investment in intangible assets, on valuation coefficients of earnings and book value of equity (BVE). Failure to control for uncertainty related to limited prior information causes downward bias on the coefficients for intangible intensive firms. I demonstrate an informational substitution effect between earnings and BVE. High operating cash flows (OCF) mitigate the noise effect of earnings arising from intangible investments and limited prior information, increasing the informativeness of earnings. This reduces the valuation weight on BVE by reducing investors’ anxiety about intangible investments by managers. I find that the magnitude of the valuation coefficient on earnings (BVE) is higher (lower) for firms with high OCF than low OCF and the coefficient on BVE is higher (lower) than that of earnings for low (high) OCF firms.

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