Earnings quality and firm valuation: evidence from several European countries

Abstract

Purpose This study aims to investigate the association between firm valuation and earnings quality in several European countries. Also, it examines if country-level governance and market development are important determinants of firm valuation. Design/methodology/approach Using a sample of 5,002 non-financial firms in 37 European countries over the years 2004 to 2019, the authors evaluate the research question using regression models. Findings The authors find a significant positive relationship between firm valuation and a multi-factor earnings quality measure based on four components (accruals, cash flows, operating efficiency and exclusions). The authors further show that stock market development is also a driver of firm value, while country-level governance is significant only in the case of a firm fixed effect model with time effects. The results are robust to alternative model specifications that control for endogeneity, sample heterogeneity and alternative proxies for firm valuation. Practical implications Policy makers and market participants could benefit from the findings, by exploiting the advantages of earnings quality in terms of high-ranking stocks whose earnings are backed by cash flows and other sustainable sources. Originality/value To the best of the authors’ knowledge, this study is the first to empirically test the relationship between earnings quality and firm value in the European setting during a period that incorporates the adoption of IFRS. This is quite interesting as it permits cross-border comparability in terms of financial reporting and provides deeper and more representative evidence.