Accounting Based Valuation: A Simultaneous Equations Model for Forecasting Earnings to Proxy for Other Informationn

Abstract

This paper develops and tests a simultaneous equations model (SEM) for extending accounting based valuation models used in empirical studies. To calculate the ‘other information’ variable in the Ohlson (1995) model, we derive forecasts of operating income from the SEM, rather than using analysts’ forecasts. The SEM forecasts are based on observable data contained in the firms’ reporting, like order backlog, and other publicly available information. The SEM produces more accurate out-of-sample forecasts of operating income compared to simple benchmark models particularly in years around economic changes and instability, like the years 2001 and 2009. Integrating the SEM forecast as ‘other information’ in market value regressions significantly increases the explanatory power compared to simpler versions with or without single information proxies for ‘other information’. The SEM forecast is able to explain a major portion of the information advantage of analysts relevant for explaining market values.