Book-to-market value of equity ratios and earnings realization
This thesis increases our understanding of the book-to-market ratio via a detailed examination of how and when earnings are realised in relation to firms' "capitalisation" and "average useful-life of assets". Book-to-market ratios (BMRs) are regressed as a function of changes in market value of equity ratios for British industrial companies registered on the London Stock Exchange from 1987 to 1996. Data from a prior period (1976-1986) is also employed to stabilise for effects of earnings realisation before the regression period. The "average useful-life assets" for the firms in the sample determines the time horizon of the analysis. The path of abnormal earnings over this horizon reflects the pattern of expiration of the useful-lives of assets in place. The analysis finds that an accrual measurement effect dominated in BMRs increases over the analysis period and also that accrual measurement is more influential in BMRs for firms with short than with long "average useful-life assets". Changes in market value ratios are found to inform about future earnings up to at least six years, except for highlycapitalised firms with long useful-life assets (for which the relationship lasts up to 4 years). The length of the informative period is found to be inverse to the average useful-life of firms' assets. The effect of differences between annual changes in market value of equity ratios on BMRs across time diminishes soon (two years) after the initial market shock' occurs. Long useful-life assets have no further effect on BMRs evolution at more distant lags. Contrary to previous research (in the USA), changes in market value of equity ratios (for UK firms) are found to be associated more with short than with long useful-life assets. Although not specially tested for, this result supports the notion of "short-terminism" of which the UK stock market is sometimes accused. The apparent "short-terministic" outlook by investors in UK firms coincides with improved predictability of BMRs in the UK compared with the US market. The high coefficients of determination from changes in market value of equity ratios as a function of BMRs, identified in the study, motivates a further test for a prediction model which is able to predict 29.2% of the variation in book-tomarket value of equity ratios 8 years in advance.