The Impact of Valuation Models on Value-Relevance Studies in Accounting: A Review of Theory and Evidence

Abstract

This paper reviews some of the theory and evidence associated with value-relevance studies in accounting. Two valuation models are commonly used in value-relevance studies, namely the price model and the return model. Although their theoretical foundations are the same, the results obtained using these two models are sometimes inconsistent. The problem related with the price model is often referred to as 'scale effects' and those with the return model are termed 'accounting recognition lag' and 'transitory earnings'. Some methods to mitigate these problems are suggested by researchers. However, none of them leads to a perfect solution to these problems and the inconsistent results remain unexplained. Perhaps, in the absence of a definite solution, using both the price and the return models is the most appropriate response despite the fact that this may lead to ambiguous conclusions.