Earnings in Firm Valuation and Their Value Relevance

This paper examines the explanatory power of earnings in equity valuation and value relevance of earnings through a combination of cross-section and time series regression analysis. Cross-section models are based upon all US firms with a 31 December year-end in the Compustat files between 1960 and 2009. Time series models are based on a sample of 30 long-lived firms with 55 years of continuous data through to 2009. The cross-section models show a decreasing magnitude in the elasticity of market value with respect to earnings over time relative to book value, suggesting a decline in value relevance of earnings. However, we show the pattern of a reducing value relevance of earnings is explained by an increasing incidence of reported losses. The value relevance of other income not reported immediately through the income statement is uniformly low over the entire period studied. We find no direct evidence that the increased incidence of losses is due to poor earning quality or earnings management.