Estimating economic performance from accounting data—a review and synthesis

Stark, Andrew

doi:10.1016/j.bar.2004.06.005

Cited by 24 publications

(9 citation statements)

References 43 publications

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“…This interesting result is in sharp contrast with the accounting literature on economic rate of return, according to which accounting rates of return do not provide any information about a project's or firm's economic profitability (e.g. Harcourt 1965, Solomon 1966, Livingstone and Salamon 1970, Gordon 1974, Kay 1976, Fisher and McGowan 1983, Luckett 1984, Salamon 1985, Kay and Mayer 1986, Gordon and Stark 1989, Whittington 1988, Feenstra and Wang 2000, Stark 2004. See also Magni 2009a, 2011c, Magni and Peasnell 2012, 2015.…”

Section: The Average Return On Asset (Aroa)contrasting

confidence: 51%

Capital depreciation and the underdetermination of rate of return: A unifying perspective

Magni

2016

Journal of Mathematical Economics

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Abstract. This paper shows that the notion of rate of return is best understood through the lens of the average-internal-rate-of-return (AIRR) model, first introduced in Magni (2010a). It is an NPVconsistent approach based on a coherent definition of rate of return and on the notion of Chisini mean, it is capable of solving the conundrums originated by the rate-of-return notion and represents a unifying theoretical paradigm under which every existing measure of wealth creation can be subsumed. We show that a rate of return is underdetermined by the project's cash-flow stream; in particular, a unique return function (not a unique rate of return) exists for every project which maps depreciation classes into rates of return. The various shapes a rate of return can take on (internal rate of return, average accounting rate of return, modified internal rate of return etc.) derive from the (implicit or explicit) selection of different depreciation patterns. To single out the appropriate rate of return for a project, auxiliary assumptions are needed regarding the project's capital depreciation. This involves value judgment. On one side, this finding opens terrain for a capital valuation theory yet to be developed; on the other side, it triggers the creation of a toolkit of domainspecific and purpose-specific metrics that can be used, jointly or in isolation, for analyzing the economic profitability of a given project. We also show that the AIRR perspective has a high explanatory power that enables connecting seemingly unrelated notions and linking various disciplines such as economics, finance, and accounting. Some guidelines for practitioners are also provided.

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Section: The Average Return On Asset (Aroa)contrasting

confidence: 51%

Capital depreciation and the underdetermination of rate of return: A unifying perspective

Magni

2016

Journal of Mathematical Economics

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“…Previous studies in this field, including McGahan and Porter (1997), Rumelt (1991) and Schmalensee (1985) acknowledge similar difficulties. Fisher and McGowan (1983) and Stark (2004) discuss the issues that arise in the measurement of profitability.…”

Section: Data and Variable Definitionsmentioning

confidence: 99%

Sources of variation in firm profitability and growth

Goddard

Tavakoli

Wilson

2009

Journal of Business Research

100

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“…Some organizations, like the OECD, have also used ROI measures for country-wide comparisons of profitability; see, for instance, Chan-Lee and Sutch (1985). 2 Earlier studies exploring the connection between IRR and ROI include Solomons (1961), Solomon (1966), Fisher and McGowan (1983), Salamon (1985Salamon ( , 1988, Bar-Yosef and Lustgarten (1994) and Stark (2004). 3 Feltham and Ohlson (1996), Ohlson and Zhang (1998) and Zhang (2000) refer to accounting as conservative if on average market values exceed book values.…”

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confidence: 98%

“…6 A central question in the industrial organization literature is whether in the long run firm profits tend to revert to competitive levels. To answer this question, a variety of profit measurement methodologies have been developed; see, for instance, Mueller (1986) and Stark (2004). Some authors, including Fisher and McGowan (1983), have argued that it is generally impossible to infer economic profitability from reported accounting rates of return.…”

mentioning

confidence: 99%

Conservatism, growth, and return on investment

2007

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Return on Investment (ROI) is widely regarded as a key measure of firm profitability. The accounting literature has long recognized that ROI will generally not reflect economic profitability, as determined by the internal rate of return (IRR) of a firm's investment projects. In particular, it has been noted that accounting conservatism may result in an upward bias of ROI, relative to the underlying IRR. We examine both theoretically and empirically the behavior of ROI as a function of two variables: past growth in new investments and accounting conservatism. Higher growth is shown to result in lower levels of ROI provided the accounting is conservative, while the opposite is generally true for liberal accounting policies. Conversely, more conservative accounting will increase ROI provided growth in new investments has been ''moderate'' over the relevant horizon, while the opposite is true if new investments grew at sufficiently high rates. Taken together, we find that conservatism and growth are ''substitutes'' in their joint impact on ROI.

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Estimating economic performance from accounting data—a review and synthesis

Cited by 24 publications

References 43 publications

Capital depreciation and the underdetermination of rate of return: A unifying perspective

Capital depreciation and the underdetermination of rate of return: A unifying perspective

Sources of variation in firm profitability and growth

Conservatism, growth, and return on investment

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