Abstract

This article regresses the market value of equity on pre-depreciation income and on depreciation expense for capital-intensive firms, referring to the coefficients from our model as valuation weights. The valuation weight on depreciation expense versus the weight on pre-depreciation income are compared, to detect depreciation biases, over time and across sectors. Our model shows that the valuation weights on depreciation expense change over time, if the persistence of the cash flow components of net income varies over time and if the accrual for depreciation is inflexible (e.g., straight-line depreciation). For Real Estate Investment Trusts (REITs), we find the valuation weight on pre-depreciation income increases with industry upturns, while the valuation weight on depreciation expense decreases during upturns. This result is contrasted to the nearly equal valuation weights for the cash flow and depreciation components of earnings for Resource firms (e.g., mines) over time. We conjecture this is because depletion accounting flexibly allows for “depreciation” to exhibit less bias than in other sectors. In summary, actual depreciation practices influence time variation in the valuation of depreciation, a point which has been underappreciated in prior studies.

Talk to us

Join us for a 30 min session where you can share your feedback and ask us any queries you have

Schedule a call

Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.