Chen Zhang 2003

Heterogeneous investment opportunities in multiplesegment firms and the incremental
value relevance of segment accounting data
Peter F. Chen and Guochang Zhang
Accounting Review. 78.2 (Apr. 2003): p397+.
Copyright: COPYRIGHT 2003 American Accounting Association
http://accounting.rutgers.edu/raw/aaa
Resumo:
Applying a realoptionsbased valuation approach, we develop and test a model that addresses the
incremental value relevance of segment data beyond firmlevel accounting data. Prior studies (e.g.,
Zhang 2000; Biddle et al. 2001) show that equity valuation requires accounting data (in part)
because accounting provides signals that guide capital investments underlying value creation. In
this study, we establish that the usefulness of segment data beyond aggregate data relates to
heterogeneity of investment opportunities across segments, caused by divergences of segment
profitability and growth potential. Empirical results are consistent with the model's predictions. We
also assess the magnitude of the valuation impact of segment information relative to that of firm
level information. valuation approach, we develop and test a model that addresses the incremental
value relevance of segment data beyond firmlevel accounting data. Prior studies (e.g., Zhang
2000; Biddle et al. 2001) show that equity valuation requires accounting data (in part) because
accounting provides signals that guide capital investments underlying value creation. In this study,
we establish that the usefulness of segment data beyond aggregate data relates to heterogeneity
of investment opportunities across segments, caused by divergences of segment profitability and
growth potential. Empirical results are consistent with the model's predictions. We also assess the
magnitude of the valuation impact of segment information relative to that of firmlevel information.
Keywords: segment accounting data; incremental value relevance; real options; divergence of
profitability; segment growth opportunity.
Data Availability: Data used in this study are available from public sources.
Texto completo:
I. INTRODUCTION
Valuation of a firm with multiple business components requires information not only about the firm's
overall operations, but also about the operations of individual components (segments) within the
firm. Analysts and investors view segment data as vital and essential for investment analysis, (1)
and they demand segment data that enhance their ability to predict management actions that affect
future cash flows (SFAS No. 131, FASB 1997). In response to calls from the investment community
for more disaggregated information, standard setters and regulators worldwide have recently made
considerable efforts to expand segment disclosure requirements (e.g., SFAS No. 131; No. 14R,
International Accounting Standards Committee [IASC] 1997) and to enforce the rules. (2) Despite
the importance of segment data to users and regulators, there has been limited academic research
to formally examine their role for valuation. In this study, we employ a realoptionsbased model to
address the following question: Given aggregate data that firms are already required to report, how
is equity value related to the information conveyed incrementally by segment data? (3) We first
develop a model to show how equity value depends on both firmlevel and segment accounting
information, and then empirically tests the model's predictions.
It is well known that firm value reflects the value of real options, i.e., opportunities to expand or
contract the scale of operations (e.g., Myers 1977; Kester 1984; de Matos 2001). Real options exist
in virtually all types of business operations, and they often constitute a significant portion of firm
value. Accounting research has previously examined the implications of firmlevel real options or,
equivalently, treated firms as singlesegment operations (e.g., Hayn 1995; Berger et al. 1996;
Burgstahler and Dichev 1997; Zhang 2000; Yee 2000; Biddle et al. 2001), but the underlying idea
can be readily extended to firms with multiple business segments. In this study, we recognize that
in a multiplesegment firm, different segments generally face different investment opportunities (due
to different external market conditions), and have different abilities to exploit external opportunities
(due to differential abilities to manage business). In a model that incorporates segmentlevel real
options, we decompose equity value into (1) the part explained by aggregate firmlevel accounting
data, and (2) an incremental component attributable to differences across segments in operating
profitability and investment opportunities as conveyed by segmentlevel data. This characterization
enables us to evaluate the importance of segmentlevel, vs. firmlevel, data in value determination
and to explain crosssectional variations in the relative importance of segment data as driven by
underlying economic conditions.
To examine the incremental value relevance of segment data, we first consider the case where a
firm's segments have equal profitabilities and growth opportunities. Under these special conditions,
segments have identical real options, and firm value can be determined solely by firmlevel data.
When segments have divergent profitabilities, valuation requires not only firmlevel accounting data
to convey about firm overall operations, but also segmentlevel data to convey differences among
segments. A key valuation construct is divergence of profitability (DOP), which indicates the
differential abilities of segments in exploiting investment opportunities. The incremental value
relevance of segment data increases with DOP, because DOP is positively associated with the
heterogeneity of investment decisions across segments.
More generally, when a firm's segments operate in industries or markets that have different growth
opportunities, equity value depends not only on the divergence of profitability, but also on the
distribution of growth opportunities across segments. When most of a firm's growth opportunities lie
in segments that are relatively profitable, a situation advantageous to the firm in exploiting external
opportunities, DOP increases total firm value (relative to where segments have equal profitability).
On the other hand, when most of the firm's growth opportunities lie in segments that are relatively
unprofitable, a situation disadvantageous to the firm in exploiting opportunities, DOP reduces firm
value.
We perform empirical analysis on data from the Compustat industry segment file for the period
19861997, and obtain the following results. First, controlling for firmlevel accounting information,
DOP exhibits a significantly positive effect on equity value. Second, the incremental value effect of
a given DOP varies with firm overall profitability and growth opportunity as predicted. Third, the
distribution of segment growth opportunities within a firm is important in determining the value
effect of DOP; the incremental value effect of DOP is positive if growth opportunities are more
highly concentrated in segments that are relatively profitable, and is negative if the opposite is the
case. Overall, the empirical results are consistent with qualitative predictions of the model.
The magnitude of the value effect of DOP is shown to be economically significant. For example, on
a broadbased sample, the estimated equity value change associated with a change of 0.10 in
DOP (approximately 2 standard deviations in partitioned samples) ranges from +6.7 percent to 6
percent, depending on how growth opportunities are distributed within the firm. On the other hand,
the incremental explanatory power of DOP is generally small, possibly due to measurement errors
in reported segment data (see Givoly et al. 1999).
Our study suggests that when valuing multiplesegment firms, firmlevel data need to be
supplemented by information that reflects differences in segment profitability and growth
opportunities, the underlying causes for segments to pursue heterogeneous investment decisions.
This is in line with the arguments for disclosure of disaggregated information made by analysts and
standard setters. In addition, by establishing a link between the valuation relevance of segment
data and their use in managerial decisions, our study suggests that it is beneficial to organize
external reporting of segment data in a way consistent with the internal use of such data by
managers. In this sense, our analysis supports both the management approach underlying SFAS
No. 131 and the SEC requirement to organize the Management Discussion and Analysis (MD&A)
in a way that portrays the firm "through the eyes of management." Also, our result that segments
can be aggregated when they have similar profitabilities and growth opportunities is consistent with
the aggregation criteria recommended in SFAS No. 131. (4)
The remainder of the paper is organized as follows. Section II reviews prior research. Section III
develops a realoptionsbased valuation model for multiplesegment firms, which leads to testable
hypotheses. Section IV describes variable measurement and data. Section V reports empirical
results, and Section VI discusses implications and concludes the paper.
II. PRIOR LITERATURE
A number of prior studies have examined the role of segment accounting data in valuation, with
different approaches employed. (5) Foster (1975) compares market performances of portfolios
formed by aggregateearnings news vs. portfolios formed by subearnings news (earnings news is
classified into negative or positive changes), and finds systematic differences in portfolio returns.
This evidence, however, may merely indicate differential stock market reactions to the different
magnitudes of firmlevel earnings (as the magnitude of total earnings is expected to differ
systematically across portfolios), and may not necessarily suggest that earnings disaggregation,
per se, provides relevant information.
More closely related to our study is Wysocki (1998) who adopts a realoptions framework to predict
how the valuation consequence of segment earnings differs for different segments. Based on a
sample of twosegment firms, Wysocki finds that (1) earnings coefficients are higher for profit (vs.
loss) segments, for more profitable (vs. less profitable) segments, and for the primaryindustry
segment whose growth opportunity exceeds that of the secondaryindustry segment; and (2) the
incremental explanatory power of earnings is higher for profit segments than for loss segments.
These findings indicate that the usefulness of segmentlevel data depends on whether segments
differ in their profitabilities and growth opportunities.
Basu et al. (1999) model and test the usefulness of segment earnings in relation to segment
earnings attributes (namely, differences in persistence, variances, and correlation). They run
separate regressions of stock returns on firmlevel data and on segment data. Based on
comparison of regression coefficients on segment earnings with that of aggregate earnings, they
find that the usefulness of segment data depends on the above earnings attributes. Givoly et al.
(1999) employ similar regressions but their comparison focuses on regression [R.sup.2]s. They find
that increases in [R.sup.2]s are small when component segment earnings, instead of firmlevel
earnings, are used to explain returns, a result also reported by Basu et al. (1999).
The above studies treat segment earnings as alternative, rather than incremental, explanatory
variables to firmlevel earnings. They do not address the incremental role of segment data in a
valuation model that already incorporates firmlevel data, or how segment data help to "fine tune"
equity valuation. This issue is pertinent to practice because segment data are provided as
supplementary disclosures, and regulators and users evaluate the usefulness of segment data
given firmlevel data.
One study that incorporates segment data to supplement aggregate earnings is Tse (1989), who
finds that the percentage of total earnings derived from a "high" (vs. "low") growth industry is
additionally valuerelevant. Tse (1989), however, does not develop a theoretical model to show
endogenously what types of segment data matter incrementally and what their predicted effects
are; his analysis focuses on one specific type of segment data.
Our study contributes to further understanding the usefulness of segment data, both theoretically
and empirically. Our model shows why segment data incrementally matters, how valuerelevant
information is extracted, and how its incremental valuation impact varies with divergence of
segment profitability, firm overall profitability, overall growth opportunity, and the distribution of
growth opportunities within the firm. The study also provides an assessment of the magnitude of
the valuation impact of segment information relative to that of firmlevel information.
III. THE VALUATION MODEL AND PREDICTIONS
This section develops a valuation model for multiplesegment firms to examine the incremental
valuation role of segment data. The model is an extension of Zhang (2000), which introduces real
options into the valuation framework of Ohlson (1995) and Feltham and Ohlson (1995, 1996). The
notion that equity value reflects real options is empirically supported by Berger et al. (1996), Hayn
(1995), Burgstahler and Dichev (1997), Wysocki (1999), and Collins et al. (1999).
A SingleSegment Firm Valuation Model
According to Zhang (2000), and consistent with Burgstahler and Dichev (1997), equity value can be
viewed as equal to the value from existing operations plus the value of options to grow or to
contract the operating scale, and it is a function of the firm's profitability and growth opportunities.
For expositional clarity, we present a simplified version of Zhang's (2000) model, used as the basis
for developing our analysis for multiplesegment firms. (6)
Let V be the intrinsic value of an allequity financed firm, A the amount of asset stock currently
employed in operations, E the currentperiod earnings, g the growth opportunity, i.e., the
percentage by which the scale of operations (as measured by assets) can grow, and c the earnings
capitalization factor. (7) Define q [equivalent to] E/A as the firm's current operating profitability.
Following Zhang (2000), the value of a firm with a growth and an adaptation option can be
expressed as a function of q as follows:
(1) V = AP(q) + cE + AgC(q) = A[P(q) + cq + gC(q)],
where P(q) is the (put) option that allows the firm to adapt assets, and C(q) the (call) option that
allows the firm to grow, both of which are normalized by assets. The options' values depend on
current profitability (q) as long as current profitability is informative about future profitability and
hence affects the likelihood that the options will be exercised. Embedded in these options are two
critical profitability levels (the "exercise prices"), denoted [q.sup.*.sub.a] and [q.sup.*.sub.g],
[q.sup.*.sub.a] < [q.sup.*.sub.g], such that the firm will adapt its assets if future profitability is below
[q.sup.*.sub.a], expands operations if future profitability is above [q.sup.*.sub.g], and maintains the
existing scale in between. A property important for the analysis below is that equity value V as
given by Equation (1) is an increasing and convex function of q, with the degree of convexity
increasing with growth opportunity g.
Valuation of MultipleSegment Firms
Consider a firm with two segments, labeled segments 1 and 2, where each segment can choose to
adapt its resources or to grow, irrespective of the other segment's decision. Following the above
analysis, each segment has a value expression analogous to Equation (1). Combining the two
segments, we obtain firm value as: (8)
(2) [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]
where, by definition, [q.sub.1] = [E.sub.1]/[A.sub.1] and [q.sub.2] = [E.sub.2]/[A.sub.2], and
subscript 1 or 2 identifies a segment.
Let A and E be the firm's total assets and currentperiod earnings, respectively, with A = [A.sub.1] +
[A.sub.2] and E = [E.sub.1] + [E.sub.2], and let q = E/A be the firm's overall profitability. Then, q is a
weighted average of segment profitabilities, q = [w.sub.1][q.sub.1] + [w.sub.2][q.sub.2], with weights
[w.sub.1] = [A.sub.1]/A and [w.sub.2] = [A.sub.2]/A.
Due to the option terms, valuation function (2) is a nonlinear function of segment assets ([A.sub.1],
[A.sub.2]), segment profitability ([q.sub.1], [q.sub.2]), and growth opportunities ([g.sub.1], [g.sub.2]).
This nonlinearity generally makes it inappropriate to replace segment earnings and book values in
Equation (2) with firmlevel data, suggesting that firmlevel accounting data alone do not provide
sufficient information for valuation.
Of special interest are situations where segment data can be aggregated in Equation (2). This
occurs when the segments have equal profitability ([q.sub.1] = [q.sub.2]) and equal growth
opportunities ([g.sub.1] = [g.sub.2]). Under these conditions, segments have identical real options,
and Equation (2) simplifies to:
(3) V = AP(q) + cE +Ag C(q),
equivalent to the value expression for a singlesegment firm, Equation (1), where firm overall
growth opportunity g coincides with [g.sub.1] and [g.sub.2] in this case.
In general, when segments differ in profitability and growth opportunities, segmentlevel data are
necessary to supplement firmlevel data to convey additional relevant information. Below, we
examine the incremental relevance of segment data first for the case where segments have equal
growth opportunities and then extend the analysis to more general situations.
The Incremental Relevance of Segment Data When Segments Have Equal Growth Opportunities
([g.sub.1] = [g.sub.2] = g)
The segments have same growth opportunities if, for example, they operate in the same (or similar)
market environments. Designate the less profitable segment as segment 1 and the other as
segment 2, i.e., [q.sub.1] [less than or equal to] [q.sub.2]. Define DOP [equivalent to] [q.sub.2]
[q.sub.1] [greater than or equal to] 0 as the divergence of profitability between the segments. Let
DOP = 0 (i.e., [q.sub.2] = [q.sub.1]) be a benchmark case, with firm value given by Equation (3). (9)
Figure 1 illustrates how DOP affects firm value incremental to firmlevel data under a convex
valuation function. (10)
[FIGURE 1 OMITTED]
Curve AB in Figure 1 represents value, normalized by assets, as a function of profitability; it applies
to each individual segment and also to the whole firm in the benchmark case (DOP = 0). When
both segments' profitabilities (and hence firm overall profitability) equal q, the normalized firm value
and that of each segment are all indicated by point M (on curve AB). As segment profitabilities
move apart to [q.sub.1] (for segment 1) and [q.sub.2] (for segment 2), while holding firm overall
profitability unchanged at q, the (normalized) value of segment 1 moves to point J and that of
segment 2 to K. Based on Equation (2), it can be shown that the normalized firm value is a
weighted average of normalized segment values, (11) which is now indicated by point N. Given that
the valuation function is convex, N lies above M, suggesting that, relative to the benchmark case of
DOP = 0, firm value is greater when segment profitabilities move apart. (12) Distance NM
represents the incremental value effect of DOP, denoted [DELTA]v. It is obvious from Figure 1 that
given overall profitability q, [DELTA]v increases with DOP. Our first hypothesis, stated in alternative
form, is:
H1: Divergence of segment profitability (DOP) has a positive incremental effect on equity value,
given firm overall profitability q. (13)
However, the magnitude of [DELTA]v associated with a given DOP depends on how convex the
valuation function is around profitability q. The more convex the valuation function around q, the
greater the incremental value impact of a given DOP. In one extreme where value is linear in
profitability, the effect of DOP vanishes.
According to the established option theory (e.g., Hull 2000), option value (either put or call) is
generally convex, but the degree of convexity is the highest where the option is "at the money" (i.e.,
where the price of the underlying asset equals the exercise price). Moving away in either direction
from this point, option value becomes less convex and gradually approaches linearity. (14) In our
valuation context, these properties suggest that the valuation function is most convex near
[q.sup.*.sub.a] and [q.sup.*.sub.g], the critical profitability levels for adaptation and growth
decisions. The two options jointly induce the following behavior of [DELTA]y: For a given DOP,
[DELTA]v reaches a maximum when firm profitability q is near [q.sup.*.sub.a] and also near
[q.sup.*.sub.g] (where the valuation function is most convex); [DELTA]v increases with q to the left
of [q.sup.*.sub.a] and decreases with q to the right of [q.sup.*.sub.g], approaching zero in both
extremes where q [much less than] [q.sup.*.sub.a] or q [much greater than] [q.sup.*.sub.g].
Between [q.sup.*.sub.a] and [q.sup.*.sub.g], [DELTA]v decreases with q in the region near
[q.sup.*.sub.a] (where the effect of the adaptation option dominates that of the growth option) and
increases with q in the region near [q.sup.*.sub.g] (where the effect of growth option dominates),
forming a valley between the two maximums.
Figure 2 shows the simulation results on how [DELTA]v behaves in relation to q for a range of
different DOP values. It confirms the qualitative trend predicted in the above discussion. As shown
in the figure, the parameter values underlying the simulation are comparable to those of average
firms in our empirical sample. The figure gives a general indication that the magnitude of the
incremental effect of DOP, while not comparable to that of firmlevel information, would be (on
average) economically important for firms and investors. Furthermore, this effect varies
considerably across firms. (This general point also applies to the additional simulation in Figure 4
below.)
[FIGURES 2 & 4 OMITTED]
H2: In the extreme lowq region, [DELTA]v is close to zero. As q increases, [DELTA]v first
experiences an increasing trend, followed by a decreasing trend, and then another increasing trend
followed by a decreasing trend, and it eventually approaches zero in the extreme highq region.
In Figure 2, the peaks on the right are induced by the growth options. These curves are based on a
particular value of g (with different values of DOP). From Equations (2) and (3), growth
opportunities have a multiplying effect on value; therefore, as g increases, the incremental value
effect [DELTA]v of a given DOP also increases. In the special case where g = 0, there are no
growth opportunities, and the peaks on the right would disappear in Figure 2.
H3: The incremental value ([DELTA]v) of a given DOP increases with growth opportunity g.
The Incremental Relevance of Segment Data When Segments Have Different Growth
Opportunities ([g.sub.1] [not equal to] [g.sub.2])
When segments have different growth opportunities, segment data relate to equity value in a more
complex way because equity value also depends on the divergence of growth opportunity between
the segments. To isolate the effect of growth opportunities, we distinguish firms with high
profitability from those with low profitability. Our analysis below focuses on the highprofitability
region where growth options are an important part of firm value. In the region where profitability is
low (relative to [q.sup.*.sub.g]), growth options have little relevance to valuation (deep "out of the
money"), and [DELTA]v behaves similarly to that for the case of [g.sub.1] = [g.sub.2] above (Figure
2). Namely, [DELTA]v is negligible when q [much less than] [q.sup.*.sub.a], and, as q increases,
[DELTA]v first increases to reach a maximum near q = [q.sup.*.sub.a] and then begins to decline.
In the highprofitability region, the incremental value effect of DOP is illustrated by Figure 3, which
generalizes the special case of [g.sub.1] = [g.sub.2] in Figure 1. With [g.sub.1] [not equal to]
[g.sub.2], two value curves are needed to depict the relation between segment value and
profitability: The more convex curve, AB, corresponds to the segment with higher growth
opportunity, whereas the less convex AC corresponds to the segment with lower growth opportunity
(all values normalized by assets); the segments' values are approximately the same when
profitability is low. As before, our benchmark is the special case of [q.sub.1] = [q.sub.2] = q, with
firm value given by:
(3') V = ([A.sub.1] + [A.sub.2])P(q) + c([A.sub.1] + [A.sub.2])q + [A.sub.1][g.sub.1]C(q) + [A.sub.2]
[g.sub.2]C(q).
[FIGURE 3 OMITTED]
The normalized firm value, a weighted average of normalized segment values (see footnote 11), in
the benchmark is indicated by point M, which lies between two segments' values. As segment
profitabilities diverge, while keeping firm profitability unchanged at q, segment values move along
their respective value curves. There are two distinct scenarios.
Scenario (i): The more profitable segment has higher growth opportunity ([g.sub.1] < [g.sub.2]).
When [g.sub.1] < [g.sub.2], AB (the more convex curve) corresponds to segment 2 and AC to
segment 1. Starting from the benchmark where both segments have profitability q, let segment
profitabilities diverge to [q.sub.1] (for segment 1) and [q.sub.2] (for segment 2) but without changing
overall profitability q. The value of segment 1 moves to J, and that of segment 2 to K. The
normalized firm value is given by N, located above the benchmark value at M. In this case, as in
the case of [g.sub.1] = [g.sub.2] above, DOP has a positive incremental effect on firm value, with
the magnitude of the effect measured by distance NM.
Scenario (ii): The less profitable segment has higher growth opportunities ([g.sub.1] > [g.sub.2]).
When [g.sub.1] > [g.sub.2], Figure 3 is reinterpreted so that now curve AB corresponds to segment
1 and AC to segment 2. The value of segment 1 is given by point J', and that of segment 2 by K'.
The firm value is given by N', located below M. In this case, and contrary to the case of [g.sub.1]
[less than or equal to] [g.sub.2], DOP has a negative incremental value effect, with the magnitude
of the effect represented by distance MN'. (15)
Intuitively, the incremental value of DOP depends on how growth opportunities are distributed
within the firm. A more profitable segment is more capable of generating value from given
investment opportunity than a less profitable segment. Thus, the situation is advantageous to the
firm if most of its opportunities lie with the relatively profitable segment (as in Scenario (i) above),
but is disadvantageous if the opposite is true (as in Scenario (ii) above). This explains why the
value effect of DOP is positive in the former scenario and negative in the latter, relative to
benchmark value given by Equation (3').
The generality of the above predictions are confirmed by the simulation result in Figure 4. The
difference in growth opportunity between segments is defined as [DELTA]g = [g.sub.2] [g.sub.1].
(16) Each curve shows how [DELTA]v changes with q for a given [DELTA]g. Two observations can
be made. First, [DELTA]g matters to valuation in the highprofitability region, but not in the low
profitability region where the behavior of [DELTA]v is similar to the case of [g.sub.1] = [g.sub.2]
shown in Figure 2. Second, in the highprofitability region, [DELTA]v increases with [DELTA]g, and
the sign of [DELTA]v is closely related to that of [DELTA]g, as is illustrated in Figure 3.
H4: In the highprofitability region, the incremental value of DOP (relative to the benchmark of DOP
= 0), [DELTA]v, increases monotonically with [DELTA]g; [DELTA]v > 0 if [DELTA]g >0, and [DELTA]v
< 0 if [DELTA]g <0.
IV. EMPIRICAL MEASURES AND DATA
We obtain segment data from the Compustat industrysegment file for period 19861997, firmlevel
data from the Compustat annual data file, and stock prices from the CRSP database. Equity value
at year t ([V.sub.t]) is measured by market value of common shares, equal to the number of shares
outstanding (item #25) times the stock price three months after fiscal yearend. Beginning equity
book value [B.sub.t1] (item #60) is used as a deflator for [V.sub.t]. Firm overall profitability
([q.sub.t]) is measured by return on book equity, i.e., earnings ([E.sub.t]) divided by beginning book
equity ([B.sub.t1]), where [E.sub.t] is the firm's aggregate earnings before extraordinary items
available for common shares (item #237), and [B.sub.t1] proxies for the capital contributed by
equityholders plus retained earnings (which corresponds to variable [A.sub.t1] in the above model
with allequity financing).
At the segment level, we use return on operating assets, defined as segment operating earnings
O[E.sub.t] (industrysegment file item #2) divided by beginning book value of segment identifiable
assets O[A.sub.t1] (industrysegment file item #5), to proxy for segment profitability; that is, for
segment i in period t, [q.sub.it], = O[E.sub.it]/O[A.sub.i,t1]. (17)
Extending the notion of divergence of profitability (DOP) defined in Section III, taking into account
the effect of different segment sizes, we now introduce a more general definition of DOP applicable
to empirical data as:
(4) [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]
where k is the number of segments of the firm, [q.sub.it] = O[E.sub.it]/O[A.sub.i,t1] is profitability of
segment = [[bar]q.sub.t] = [[summation of].sup.k.sub.i=1] [w.sub.it][q.sub.it] is the weighted average
of segment profitability, with weights ([w.sub.it]) defined in proportion to identifiable segment assets.
(18)
Following the theoretical model above, segment growth opportunity [g.sub.i] is a parameter about
the external environment in which a segment operates. In empirical analysis, we treat g as an
industrylevel attribute. We identify all singlesegment firms in the industrysegment database that
operate in the same threedigit SIC industry, and proxy growth opportunity (of an industry) by the
median consensus longterm growth rate of these singlesegment firms forecasted by analysts (on
I/B/E/S). (19) Thus, segments with the same threedigit SIC are considered to have the same
available growth opportunity (in any given year). (20)
We delete observations with negative book value and trim the top and bottom 0.5 percent extreme
values of E/B and V/B. (21) This results in a total of 13,463 observations. Firms having two, three,
four, and five or more segments account for 42 percent, 30 percent, 16 percent, and 12 percent of
the overall sample, respectively, and the mean (median) number of segments is 3 (3).
Table 1 provides descriptive statistics for scaled market value v, firm profitability q, and DOP, both
for individual years and for the pooled sample. The number of observations ranges from 993 in
year 1986 to 1,323 in year 1996. The mean and median values of v have a generally increasing
trend from 1986 to 1997. The mean (median) of q ranges from 0.05 (0.08) to 0.1 (0.13) during this
period, and the mean (median) of DOP remains steady at around 0.07 (0.04).
V. EMPIRICAL RESULTS
General Effect of Segment Data (H1)
We first test the incremental value effect of DOP with broad crosssectional samples (HI). Following
prior empirical studies, two benchmark models are used to control for the effect of aggregate
accounting data. The first benchmark expresses scaled equity market value v as a linear function of
scaled aggregate earnings (i.e., firm profitability q); see, for example, Burgstahler and Dichev
(1997):
(5) v = [b.sub.1] + [b.sub.2]q + [mu].
To test H1, we add DOP to Equation (5) as an incremental explanatory variable:
(6) v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP + [mu].
The second benchmark is a piecewise linear model that allows for nonlinearity of equity value in
profitability (Burgstahler and Dichev 1997):
(7) v = [b.sub.1] + [b.sub.2][D.sub.M] + [b.sub.3][D.sub.H] + [b.sub.4]q + [b.sub.5][D.sub.M]q +
[b.sub.6][D.sub.H]q + [epsilon]
where [D.sub.M] and [D.sub.H] are dummy variables for observations in the middle and high third
qvalue ranges in the sample, respectively. Again, we add DOP to test the incremental effect of
segmentlevel information:
(8) v = [b.sub.1] + [b.sub.2][D.sub.M] + [b.sub.3][D.sub.H] + [b.sub.4]q + [b.sub.5][D.sub.M]q +
[b.sub.6][D.sub.H]q + [b.sub.7]DOP + [epsilon].
With segment profitability and growth opportunity positively correlated in our sample, (22) we
predict that DOP has a positive effect on value.
Table 2 reports the annual and combined regression results for model (5) (Panel A) and model (6)
(Panel B). In both models, firm profitability (scaled aggregate earnings) is significantly related to
equity value in ten out of the 12 years and for all years combined, consistent with findings of
previous studies (e.g., Burgstahler and Dichev 1997; Collins et al. 1999). The results for model (6)
show that the coefficient of DOP is positive and significant at the 0.01 level in all 12 years
individually and combined.
However, the explanatory powers of these linear models are small. For the overall sample, the
adjusted [R.sup.2] is 1 percent for benchmark model (5), and it increases to 4 percent after adding
DOP as a second explanatory variable.
Results for models (7) and (8) are reported in Table 3. Consistent with Burgstahler and Dichev
(1997), Panel A shows that in model (7), coefficients on profitability q ([b.sub.4], [b.sub.5], and
[b.sub.6]) are statistically significant in annual regressions and for the combined sample, except for
[b.sub.5] in three of the 12 years. Panel B shows that DOP as an incremental explanatory variable
is significant at the 0.01 level in eight of the 12 years and for all years combined, significant at the
0.05 level in two years, and not significant at the 0.05 level in two remaining years.
The explanatory power of piecewise linear model (7) is 23 percent for the overall sample,
substantially higher than that of linear model (5). However, the incremental explanatory power of
DOP is low, which ranges from 0 to 3 percent for annual samples, and is 1 percent for the overall
sample. (23)
Together, the results in Tables 2 and 3 are consistent with H1 that DOP generally has a positive
impact on firm value, incremental to aggregate accounting data, (24) but the incremental
explanatory power of DOP is generally low.
FirmLevel Characteristics and the Incremental Value Effect of DOP (H2 and H3)
After showing the incremental value effect of DOP in broadbased samples, we next explore how
the effect varies across firms.
Firm Overall Profitability and the Effect of DOP (H2)
Hypothesis 2 is examined with two different samples. We first use the pooled sample to gain a
general view, ignoring the assumption underlying H2 that a firm's segments have equal growth
opportunities. We then perform a more precise test on a subsample that approximately satisfies the
equal growth opportunity assumption.
For the overall sample, we partition observations into quintiles by firm profitability q and run
separate regressions for each of the quintiles. Table 4 reports the descriptive statistics (Panel A)
and the regression results based on model (6) (Panel B).
Controlling for firmlevel profitability q, the coefficient of DOP ([b.sub.3]) is small (0.39) and
insignificant for the extremelow profitability quintile q1 (q < 0.1 percent); it then increases to 2.76 in
the second quintile q2 (0.1 percent [less than or equal to] q < 8.3 percent) before decreasing to
1.61 for q3 (8.3 percent [less than or equal to] q < 13.4 percent) and further to 0.70 for q4 (13.4
percent [less than or equal to] q < 19.6 percent). The coefficient then rises to 2.38 for the extreme
high profitability quintile q5 (q [greater than or equal to] 19.6 percent). Coefficient [b.sub.3] is
significant for quintiles q2 to q5.
These results are generally consistent with H2 in lowprofitability ranges, which predicts that DOP
has little incremental effect for extremelow qvalues, and, as q increases, its effect first rises and
then falls. However, the relatively large DOP coefficient in the highest profitability quintile q5 is at
odds with H2 where the incremental effect is predicted to be small. This discrepancy arises
possibly because the assumption underlying H2 (and Figure 2), that a firm's segments have equal
growth opportunities, is not always satisfied empirically. Note that this assumption should have little
consequence in lowprofitability regions where growth options are deep out of the money.
To test H2 more precisely, we partition the overall sample into thirds by difference in segment
growth opportunity [DELTA]g, and perform analysis only on the middle third where segments within
a firm have similar growth opportunities (i.e., [DELTA]g is close to zero). (25) The results are
presented in Panel C of Table 4. The coefficients of DOP ([b.sub.3]) based on this subsample are
0.27, 3.85, 2.31, 3.01, and 1.31 respectively for profitability partitions q1 to q5, insignificant for both
the lowest and the highest partitions (q1 and q5) but significant for the intermediate ones. The
result for lowprofitability quintiles is qualitatively the same as from the broad sample before (Panel
B), which is consistent with H2, and the result for highprofitability quintiles is in contrast to that in
Panel B and is now also consistent with H2. Moving across the entire profitability range from q1 to
q5, the pattern of variation of [b.sub.3] is similar to what is predicted by H2 (and Figure 2).
Panel C also reports the incremental [R.sup.2]s of DOP. The incremental [R.sup.2] of DOP is
virtually zero for both the lowest and the highest profitability quintiles, q1 and q5; it obtains a higher
value of 4.5 percent for q2, 1.5 percent for q3, and 2.2 percent for q4. While the incremental
explanatory power of DOP is still generally small, it shows an obvious variation across different
profitability ranges; the pattern of variation is the same as that of the DOP coefficient, and it is
consistent with H2.
Firm Overall Growth and the Effect of DOP (H3)
To explore how the value effect of segment data changes with firm overall growth opportunity g
(H3), we partition the pooled sample into quintiles by g, whereby firm overall growth is proxied by
analysts' consensus forecast of a firm's longterm growth rate. The availability of such forecasts
reduces the sample size to 7,040. Table 5 reports the descriptive statistics (Panel A) and results
(Panels B and C). Results based on linear model (6), in Panel B, shows that the coefficient of DOP,
[b.sub.3], exhibits a monotonically increasing trend with firm overall growth opportunity g across all
growthquintiles, except for the highest growth quintile g5. The increases in DOP coefficient
([b.sub.3]) for higher growth partitions, relative to lowest partition g1, are 1.15, 2.54, 4.60, and 1.75
for partitions g2 to g5, with corresponding tstatistics of 1.61 (p = 0.06), 2.54 (p = 0.002), 5.03 (p =
0.000), and 1.17 (p = 0.12), respectively, showing an increasing trend in [b.sub.3] except for g5.
Panel C provides the results for the piecewise linear model (8). The coefficient of DOP, [b.sub.7],
exhibits the same general pattern across growth partitions, as in Panel B. The increases in
[b.sub.7] for higher growth partitions relative to g1 are now 0.45, 1.45, 1.82 and 0.62 for partitions
g2 to g5, with corresponding tstatistics of 0.64 (p = 0.26), 1.82 (p = 0.04), 2.12 (p = 0.02) and 0.52
(p = 0.70), respectively, again showing a generally increasing trend of b3 except for g5. (26)
Thus, based on both the linear and the piecewise linear model, except for highest growth quintile
g5, the magnitude of the DOP coefficient exhibits an increasing trend, consistent with H3 that the
incremental value effect of DOP increases with firm overall growth opportunity. On the other hand,
the incremental [R.sup.2] of DOP (reported in Panel C for the piecewise linear model) remains
small, ranging from 0 to 1 percent.
Segment Growth Opportunities and the Value Effect of DOP (H4)
Our model further predicts that the incremental value effect of DOP depends on the distribution of
growth opportunities within the firm. We now conduct tests that explicitly recognize heterogeneity of
growth opportunities across segments (H4).
Testing H4 requires a measure of the extent to which more profitable segments have more growth
opportunity than less profitable segments ([DELTA]g). For a twosegment firm considered in the
theoretical model, [DELTA]g is defined as follows: label the less profitable segment as segment 1
and the other as segment 2, and let [g.sub.1] and [g.sub.2] be their respective growth opportunities.
The heterogeneity in growth opportunities between segment 2 and segment 1, adjusted for
segment size differences, is defined as:
(9) [DELTA]g = [w.sub.1]([bar]g [g.sub.1]) + [w.sub.2]([g.sub.2] [bar]g)
where [bar]g = [g.sub.1] * [w.sub.1] + [g.sub.2] * [w.sub.2] is the weighted average growth
opportunity of the firm, with weights [w.sub.1] and [w.sub.2] defined in proportion to beginning book
values of identifiable assets. (27)
For general multiplesegment firms, we generalize Equation (9) as follows:
(10) [DELTA]g = [summation over (i)] [w.sub.i]([bar]g [g.sub.i]) + [summation over (j)] + [w.sub.j]
([g.sub.j] [bar]g)
where [bar]g is the weighted average growth opportunity; segment i's (first summation sign)
correspond to the relatively unprofitable segments with profitability below the weighted average
profitability [bar]q (defined in Section IV), and j's (second summation sign) correspond to relatively
profitable segments with profitability above [bar]q.
Our model predicts that both the sign and the magnitude of [DELTA]g are important in determining
the value effect of DOP. A positive [DELTA]g indicates that most of the firm's growth opportunities
lie in relatively profitable segments, whereas a negative [DELTA]g indicates the opposite.
Following the theoretical analysis, H4 applies to firms with high profitability. We divide the overall
sample into the low and highprofitability halves. Testing of H4 is conducted only on the high
profitability half, which is further partitioned equally into the low, middle, and high[DELTA]g
groups. We examine how the value effect of DOP changes across firms with different [DELTA]g
values. (28)
Panel A of Table 6 reports descriptive statistics for three [DELTA]gpartitions. Panel B reports the
test results. Both the sign and the magnitude of the coefficient of DOP ([b.sub.3]) are found to
relate closely to those of [DELTA]g in a way predicted by H4. Specifically, in the low[DELTA]g
partition (where [DELTA]g < 0 for all observations), DOP has a negative incremental effect on firm
value; coefficient [b.sub.3] is estimated to be 1.60, significant at the 5 percent level for onetailed
tests. (29) In the middle[DELTA]g partition, where more than half of the observations have a
positive[DELTA]g (median [DELTA]g = 0.12), the value effect of DOP is positive, with [b.sub.3] =
1.83, significant at the 5 percent level. The high[DELTA]g partition consists purely of positive
[DELTA]g observations, and the effect of DOP is positive, with [b.sub.3] = 3.23, significant at the 1
percent level. The estimates of [b.sub.3] for the three [DELTA]g partitions also confirm that the
incremental value effect of DOP increases monotonically with [DELTA]g. However, the incremental
[R.sup.2] of DOP is small, 0 percent for low[DELTA]g partition and 1 percent for middle and high
[DELTA]g partition.
We have shown previously that firm overall growth opportunity (g) affects the value effect of DOP.
To gain additional insight, we examine whether the result concerning H4 differs for firms with
different overall growth opportunities. We divide the above sample employed for H4 equally into two
groups, lowg and highg, and repeat the test for each group. Panel A of Table 7 reports the
descriptive statistics, and Panels B and C report regression results for the low and the highg
group, respectively.
For both the lowg (Panel B) and the highg group (Panel C), the result exhibits the same general
pattern as for the pooled sample (Table 6). That is, as [DELTA]g increases from negative to positive
values, the value effect of DOP also increases from negative to positive values. Thus, the sign and
the magnitude of coefficient [b.sub.3] relate to those of [DELTA]g in a way as predicted by the
model (H4). (30) However, the incremental [R.sup.2] of DOP remains small as in Table 6.
A further observation is that the extent of change of [b.sub.3] across different [DELTA]g partitions
differs between the low and the highg group. The changes are more sensitive for firms with high
growth opportunity. Among firms with low overall growth opportunity, coefficient [b.sub.3] increases
from 0.82 for the low[DELTA]g partition, to 0.88 for the medium[DELTA]g partition, and to 2.55 for
the high[DELTA]g partition; the change of [b.sub.3] from low to high[DELTA]g partition is 3.37. On
the other hand, among firms with high growth opportunity, the corresponding [b.sub.3] estimates
are 2.53, 1.46, and 2.63; the change of [b.sub.3] from low to high[DELTA]g partition is 5.16.
Further Analysis for H4
The above empirical analysis shows that the observed variations in regression coefficients are
consistent with the model's predictions, but the incremental explanatory power is generally small,
particularly for results concerning H4. One possible cause for low incremental explanatory power of
DOP, which is much lower than the explanatory power of firmlevel profitability q, is that reported
segment data might contain considerable measurement errors. The quality of segment data has
been a concern for users of financial information (see, for example, AIMR 1993; AICPA 1994).
Givoly et al. (1999) present evidence that segment data are less precise relative to firmlevel data.
Relative to firmlevel data, segment data are subject to more measurement errors due to common
cost allocation, intersegment transfer pricing, and imprecise identification of a segment's industry,
etc. Measurement error problems are likely to be more severe for firms that are organizationally
more complex and their segments more operationally interdependent (Givoly et al. 1999). In an
attempt to reduce the effect of measurement errors, we select a subsample of twosegment firms
(less complex organizational structure) with segments operating in different twodigit SIC industries
(dissimilar growth opportunities), to further test H4. The procedure for Table 6 is repeated, except
that now we partition observations into quintiles by [DELTA]g (hoping to amplify the crosssectional
variations).
Results reported in Table 8 based on this subsample show that the coefficient of DOP, [b.sub.3],
increases monotonically with the difference in segment growth opportunity [DELTA]g; the sign and
the magnitude of [b.sub.3] are closely aligned with those of [DELTA]g. While qualitatively similar to
the results from broad samples above (Tables 6 and 7), the DOP coefficient now becomes more
significant for partitions with large absolute values of [DELTA]g, both negative and positive, where
the model predicts that the effect should be the greatest, exhibiting a more clear variation across
different partitions of [DELTA]g. Furthermore, there is marked improvement in the incremental
explanatory power of DOP. The incremental [R.sup.2]s for the five [DELTA]g partitions are 2.2
percent, 0 percent, 0.1 percent, 3.3 percent, and 5.4 percent, respectively, exhibiting a trend closely
related to the (absolute) magnitude of [DELTA]g. These improved regression results provide
stronger evidence consistent with H4 than those from broader samples above.
An Assessment of the Economic Significance of Segment Data
We now assess the economic significance of segment information by addressing the issue of how
much segment information matters in valuation. We estimate the extent to which (average) equity
value changes with segment information, based on the regression results. We then explain why the
demonstrated economic significance (as will be shown below) does not contradict the generally low
incremental explanatory power reported.
To illustrate the importance of segment information, take as an example the estimated valuation
function for range 0.1 percent < q < 8.3 percent, shown in Panel B, Table 4, v = 1.31 + 3.05q +
2.76DOP. At the mean value of q = 0.05, v = 1.4625 + 2.76DOP. Based on this estimated equation,
a change of DOP by 0.05 will, on average, result in a change of firm value by approximately 9
percent, and a change of DOP by 0.10 will result in firm value to change by 18 percent (the
standard deviation of DOP within this partition is 0.09). Repeating this analysis for other quintiles in
Panel B of Table 4 yields the following estimated value changes: (31)
Change of Equity
Value Attributed to
Profitability Range DOP Change of 0.05
q1 (q < 0.001) 1.0%

q2 (0.001 [less than or equal to] q < 0.083) 9.0%
q5 [less than or equal to] q [greather than 3.3%
or equal to] 0.196)
While the incremental effect of DOP, as shown by above percentage value changes, is small
relative to the effect of firmlevel information (q), these percentages are nonetheless significant
economically. They suggest that valuation errors from ignoring or inappropriately using segment
data can be considerable and can have important consequences for both investors and firms.
Furthermore, significant variations exist in the valuation impact of segment data across firms. For
example, the effect of DOP is negligible for firms in the extreme lowprofitability range, but it
becomes more significant in higher profitability ranges.
The empirical analysis above also reveal that the value effect of DOP can be either positive or
negative, depending on the distribution of growth opportunities within the firm (as characterized by
[DELTA]g). As further illustration of crosssectional differences, we repeat the above exercise for
the regressions reported in Panel C of Table 7, with the following result:
Change of Equity Value Attributed

Segmental Growth to DOP Change of 0.05
Differences
Low [DELTA]g -3.0%

Medium [DELTA]g 1.9%
High [DELTA]g 3.3%
Again, the estimated percentage changes in equity value indicate that the extent of valuation errors
can be considerable if one ignores or misuses segment data. Furthermore, the relative importance
of segment data varies considerably across firms that face different bundles of investment
opportunities. For example, (among firms having high growth opportunity) an increase of DOP by
0.05 is on average predicted to result in a 3 percent drop in firm value in the low[DELTA]g group,
but a 3.3 percent rise in firm value in the high[DELTA]g group, with a total difference of 6.3 percent
between these two groups. (The standard deviation of DOP in each partition is about 0.06.) The
above estimated equity value changes are generally in line with the magnitudes indicated by
simulation results (Figures 2 and 4) in Section III.
While we have shown that on average segment information has a material impact on valuation, the
incremental [R.sup.2]s of DOP are generally low. To reconcile these two aspects, we need to
distinguish the two types of information they convey. The value changes estimated from regression
results point to an average trend in how sensitively equity value changes with segment information;
this is determined by the magnitude and significance of regression coefficients. On the other hand,
the incremental [R.sup.2] measures the extent to which "residual" terms have been reduced by
adding segment information. Loosely speaking, the former corresponds to the mean and the latter
to the variance. And it is conceivable that an independent variable obtains a significant coefficient
but a low explanatory power. (32) This would happen if, for example, the independent variable,
which is theoretically important in explaining the dependent variable, contains large measurement
errors. Our evidence justifies what users have expressed, that segment data are important for
valuation but the quality of the reported segment data needs to be improved.
VI. CONCLUSIONS AND IMPLICATIONS
In this paper, we apply a realoptionsbased valuation framework to predict and test the valuation
relevance of segment accounting data, incremental to the effect of firmlevel accounting data. The
paper recognizes that different segments of a firm generally face different investment opportunities
and that an important role of segment accounting data is to guide segmentlevel investment
decisions. The key determinants of investment decisions are segmentlevel profitability and growth
opportunities. Segmentlevel data are incrementally useful because they convey the divergences of
profitability and, thus, investment decisions among segments. Our model predicts that the
incremental valuation impact of segment data varies systematically with firm overall profitability,
overall growth opportunity, and the distribution of growth opportunities within the firm. The empirical
results are generally consistent with theoretical predictions.
A general insight of the study is that, given firmlevel accounting data, the incremental usefulness
of segment data relates to the heterogeneity of investment activities across segments (in terms of
whether operations are to expand or to contract). The incremental value relevance of segment data
is greater when, for example, some segments are expected to experience growth while others are
expected to experience downsizing. On the other hand, disaggregation is not valuerelevant for
segments that have similar investment prospects.
Our study is useful to users of financial statements. It shows how valuerelevant information can be
extracted from raw segment accounting data and integrated in valuation, along with firmlevel
information, and points to circumstances where segment data matter most. The results indicate
that, on average, segment data have a material incremental impact on valuation and, thus, ignoring
or misusing such data can cause considerable valuation errors. Furthermore, the incremental
impact of segment data varies significantly across different firms. On the other hand, the study finds
that the incremental explanatory power of segment information is generally low, possibly because
reported segment data contain considerable measurement errors, as suggested by Givoly et al.
(1999) and our own analysis. (33)
Given the link between internal management decisions and the value relevance of segment data, it
is beneficial to organize external reporting of segment data in a way consistent with the internal use
of such data by management. From external users' perspectives, valuation can be facilitated if firms
disclose both the scopes of activities that managerial decisions cover and the types of information
used in making decisions. According to our analysis, information pertaining to operating profitability
and growth opportunities at the segment level is particularly relevant to valuation. In this sense, our
model supports the management approach adopted in SFAS No. 131 and SEC's MD&A
requirement to portray the firm's operations "through the eyes of management." Furthermore, our
result that segments can be aggregated when they have similar profitabilities and growth
opportunities is consistent with the aggregation criteria recommended in SFAS No. 131. However,
with generally low explanatory power of segment information, a question posed to regulators and
standard setters is: "What measures can they take to reduce the measurement error in segment
data?"
For academic research, this study provides insights into how segmentlevel data could be
transformed and incorporated in equity valuation and how empirical data could be partitioned so as
to uncover more effectively the valuation impact of segment data and its crosssectional
differences. It will be useful for future research to examine attributes of segment disclosures that
can mitigate measurement errors and increase the power of segment information in explaining
equity values.
TABLE 1
Descriptive Statistics
v q
Year n Mean Median Std. Mean
86 993 3.07 1.87 3.59 0.08

87 1,044 2.76 1.69 3.42 0.09
88 1,060 2.46 1.65 2.76 0.10
89 1,061 2.70 1.70 3.10 0.09
90 1,071 2.42 1.40 3.14 0.08
91 1,077 3.22 1.76 4.28 0.05
92 1,088 3.26 1.98 3.64 0.06
93 1,161 3.70 2.30 3.95 0.07
94 1,231 3.16 2.04 3.39 0.08
95 1,314 3.60 2.19 4.01 0.08
96 1,323 3.85 2.37 4.21 0.10
97 1,040 3.82 2.53 3.91 0.10
86-97 pooled 13,463 2.82 1.95 2.86 0.08
q DOP
Year Median Std. Mean Median Std.
86 0.11 0.18 0.07 0.05 0.08

87 0.12 0.19 0.07 0.05 0.12
88 0.13 0.19 0.08 0.05 0.12
89 0.12 0.20 0.07 0.04 0.13
90 0.10 0.19 0.07 0.04 0.14
91 0.08 0.20 0.06 0.04 0.09
92 0.10 0.22 0.06 0.04 0.07
93 0.10 0.22 0.07 0.04 0.10
94 0.11 0.23 0.06 0.04 0.07
95 0.12 0.24 0.07 0.04 0.10
96 0.12 0.21 0.06 0.04 0.08
97 0.13 0.22 0.07 0.03 0.11
86-97 pooled 0.11 0.22 0.07 0.04 0.11
v is scaled market value, defined as share price three months after

fiscal year-end times the number of shares outstanding and scaled
by beginning book value of common equity; and q is firm overall
profitability, defined as aggregate earnings available for common
stockholders divided by beginning book value of common equity.
DOP = [[summation of].sup.k.sub.i=1] |[q.sub.i] - [bar]q] * [w.sub.i]
is divergence of segment profitability of a firm, where [q.sub.i] is
profitability of segment i, defined as segment i's operating earnings
divided by its beginning identifiable assets, [w.sub.i] = weight of
segment i equal to segment i's (beginning) identifiable assets
divided by the total (beginning) identifiable assets of all reported
segments of the firm, [bar]q = [[summation of].sup.k.sub.i=1]
[w.sub.i] * [q.sub.i] is weighted average profitability of the firm,
and k = number of segments of the firm.
TABLE 2
Incremental Value Effect of Divergence of Segment Profitability (DOP)
from Linear Regressions
Panel A: Benchmark Model (5): v = [b.sub.1] + [b.sub.2]q + [mu]
Year n [b.sub.1] [t.sub.1]
86 993 2.20 27.00

87 1,044 2.16 22.30
88 1,060 2.27 24.91
89 1,061 2.07 29.50
90 1,071 1.80 25.62
91 1,077 2.19 26.61
92 1,088 2.50 31.03
93 1,161 2.84 31.20
94 1,231 2.49 31.62
95 1,314 2.80 33.53
96 1,323 2.88 30.59
97 1,040 3.17 30.68
86-97 pooled 13,463 2.43 106.38
Year [b.sub.2] [t.sub.2] Adj. [R.sup.2]
86 1.99 4.90 ** 0.02

87 1.49 3.31 ** 0.01
88 0.21 0.50 0.00
89 2.58 8.52 ** 0.06
90 2.03 6.19 ** 0.03
91 1.49 3.89 ** 0.01
92 0.24 0.67 0.00
93 1.39 3.67 ** 0.01
94 0.65 1.98 * 0.01
95 0.75 2.34 ** 0.01
96 1.64 4.09 ** 0.01
97 2.68 6.60 ** 0.04
86-97 pooled 1.44 14.60 ** 0.01
Panel B: Model (6): v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP + u
Year n [b.sub.1] [t.sub.1] [b.sub.2]
86 993 1.78 16.5 2.47

87 1,044 1.70 15.8 1.73
88 1,060 1.95 18.3 0.51
89 1,061 1.84 23.4 2.73
90 1,071 1.63 21.2 2.06
91 1,077 1.76 17.4 1.92
92 1,088 2.24 20.5 0.44
93 1,161 2.41 22.3 1.77
94 1,231 2.14 20.6 0.84
95 1,314 2.44 24.1 1.17
96 1,323 2.53 20.7 2.03
97 1,040 2.73 22.4 3.37
86-97 pooled 13,463 2.13 79.6 1.80
Year [t.sub.2] [b.sub.3] [t.sub.3] Adj. [R.sup.2]
86 6.06 5.40 5.93 ** 0.06

87 3.96 6.05 8.67 ** 0.08
88 1.26 3.94 5.74 ** 0.03
89 9.14 3.02 6.25 ** 0.10
90 6.34 2.43 5.13 ** 0.06
91 5.03 6.37 7.03 ** 0.06
92 1.22 4.30 3.63 ** 0.01
93 4.74 6.11 7.01 ** 0.05
94 2.58 5.72 5.17 ** 0.02
95 3.59 4.68 6.08 ** 0.03
96 4.97 4.93 4.31 ** 0.02
97 8.19 5.66 6.58 ** 0.08
86-97 pooled 18.20 3.89 20.80 ** 0.04
*, ** Denotes significance at the 0.05 (0.01) level, two-tailed.
[t.sub.i] represents the t-statistic for coefficient [b.sub.i].
TABLE 3
Incremental Value Effect of Divergence of Segment Profitability
(DOP) from Piece-wise Linear Regressions
Panel A: Benchmark Model (7): v = [b.sub.1] + [b.sub.2][D.sub.M]

+ [b.sub.3][D.sub.H] + [b.sub.4]q + [b.sub.5][D.sub.M] q
+ [b.sub.6][D.sub.H] q + [epsilon]
Year [b.sub.1] [t.sub.1] [b.sub.2] [t.sub.2] [b.sub.3]
86 1.34 9.20 -0.20 -0.51 -1.44

87 1.43 7.88 -0.13 -0.27 -0.92
88 1.40 8.01 0.30 0.69 -1.02
89 1.49 9.77 0.15 0.41 -0.59
90 1.31 9.15 -0.48 -1.49 -1.30
91 0.64 4.04 0.43 1.33 -0.56
92 1.35 10.60 -0.37 -0.86 -0.57
93 1.47 9.00 0.16 0.42 -1.06
94 1.72 10.89 -0.28 -0.76 -0.66
95 1.99 11.14 -0.40 -1.04 -1.04
96 2.19 14.89 -0.63 -0.85 -1.13
97 2.16 9.76 -0.26 -0.56 -1.56
86-97 1.59 43.20 -0.40 -2.66 -1.14
pooled
Year [t.sub.3] [b.sub.4] [t.sub.4] [b.sub.5]
86 -4.39 -4.96 -7.86 10.65

87 -2.37 -4.90 -6.43 8.61
88 -2.64 -5.52 -8.48 5.52
89 -2.22 -1.19 -2.21 1.99
90 -4.91 -2.91 -5.37 8.44
91 -1.86 -6.94 -12.13 14.03
92 -2.11 -6.35 -13.91 14.73
93 -3.07 -5.65 -11.12 10.63
94 -2.06 -4.20 -8.82 7.36
95 -3.13 -3.78 -7.82 7.81
96 -3.25 -4.50 -7.90 9.68
97 -3.93 -3.61 -5.93 7.56
86-97 -13.3 -4.24 -30.62 10.33
pooled
Year [t.sub.5] [b.sub.6] [t.sub.6] Adj. [R.sup.2]
86 3.08 20.29 15.30 0.27

87 1.99 15.70 10.76 0.15
88 1.51 15.80 11.23 0.15
89 0.67 9.70 10.29 0.21
90 2.76 12.74 14.85 0.25
91 4.29 21.92 19.66 0.33
92 3.43 18.62 18.29 0.33
93 3.20 21.37 17.91 0.32
94 2.29 14.09 13.03 0.21
95 2.32 15.00 13.84 0.20
96 1.66 16.65 13.61 0.19
97 2.00 19.60 15.33 0.29
86-97 7.84 17.03 54.78 0.23
pooled
Panel B: Model (8): v = [b.sub.1] + [b.sub.2][D.sub.M]

+ [b.sub.3][D.sub.H] + [b.sub.4]q + [b.sub.5][D.sub.M]q
+ [b.sub.6][D.sub.H]q + [b.sub.7]DOP + [epsilon]
Year [b.sub.1] [t.sub.1] [b.sub.2] [t.sub.2] [b.sub.3]
86 1.18 7.61 -0.21 -0.54 -1.37

87 1.13 6.23 -0.13 -0.26 -0.66
88 1.20 6.58 0.30 0.68 -0.93
89 1.49 9.77 0.15 0.41 -0.59
90 1.22 8.36 -0.49 -1.53 -1.22
91 0.53 3.22 0.42 1.34 -0.49
92 1.30 9.24 -0.37 -0.87 -0.55
93 1.31 7.68 0.16 0.44 -0.96
94 1.58 9.27 -0.26 -0.72 -0.63
95 1.84 9.91 -0.39 -1.01 -0.99
96 2.16 13.42 -0.62 -0.84 -1.10
97 2.06 9.09 -0.29 -0.62 -1.46
86-97 1.51 39.21 -0.41 -2.72 -1.07
pooled
Year [t.sub.3] [b.sub.4] [t.sub.4] [b.sub.5] [t.sub.5]
86 -4.18 -4.57 -7.10 10.60 3.09

87 -1.71 -4.16 -5.50 8.41 1.98
88 -2.46 -5.15 -7.86 5.83 1.60
89 -2.22 -1.19 -2.21 -1.99 0.67
90 -4.61 -2.80 -5.19 8.72 2.86
91 -1.62 -6.60 -11.20 13.82 4.23
92 -2.05 -6.29 -13.60 14.88 3.47
93 -2.77 -5.32 -10.40 10.68 3.20
94 -2.00 -4.06 -8.46 7.49 2.33
95 -2.98 -3.50 -7.08 7.95 2.36
96 -3.23 -4.54 -7.50 9.63 1.65
97 -3.67 -3.27 -5.18 7.79 2.06
86-97 -12.70 -3.97 -28.01 10.43 7.93
pooled
Adj.
Year [b.sub.6] [t.sub.6] [b.sub.7] [t.sub.7] [R.sup.2]
86 19.62 14.59 2.20 2.70 ** 0.28

87 13.68 9.42 4.25 6.28 ** 0.18
88 15.13 10.73 2.42 3.73 ** 0.16
89 9.74 10.33 1.64 3.52 ** 0.21
90 14.31 14.39 1.24 2.89 ** 0.26
91 21.21 18.21 2.02 2.66 ** 0.33
92 18.48 18.03 0.80 0.81 0.33
93 20.61 17.09 2.56 3.40 ** 0.33
94 13.83 12.72 2.14 2.12 * 0.22
95 14.48 13.21 2.04 2.92 ** 0.21
96 16.58 13.39 0.41 0.38 0.20
97 18.96 14.32 1.49 1.90 * 0.30
86-97 16.53 52.31 1.35 7.93 ** 0.24
pooled
[D.sub.M] and [D.sub.H] are dummy variables for firms in the

middle- and high-third q-value ranges, respectively, in a sample.
TABLE 4
Firm Profitability and the Incremental Value Effect of DOP
Panel A: Descriptive Statistics of Partitions by Firm's

Overall Profitability
v q
Partitions by Firm Std.
Profitability n Mean Med. Dev. Mean
q1 (q < 0.001) 2,693 2.40 1.14 3.62 -0.22

q2 (0.001 [less than or equal to] 2,692 1.63 1.22 1.70 0.05
q < 0.083)
q3 [less than or equal to] 0.083 2,692 1.85 1.56 1.34 0.11
(q < 0.134)
q4 [less than or equal to] 0.134 2,692 2.35 2.06 1.38 0.16
(q < 0.196)
q5 [greater than or equal to] 2,693 4.45 3.61 3.22 0.30
q (0.196)
q DOP
Partitions by Firm Std. Std.

Profitability Med. Dev. Mean Med. Dev.
q1 (q < 0.001) -0.13 0.26 0.11 0.06 0.15

q2 (0.001 [less than or equal to] 0.05 0.02 0.06 0.04 0.09
q < 0.083)
q3 [less than or equal to] 0.083 0.11 0.01 0.05 0.03 0.07
(q < 0.134)
q4 [less than or equal to] 0.134 0.16 0.02 0.05 0.03 0.08
(q < 0.196)
q5 [greater than or equal to] 0.26 0.12 0.08 0.05 0.10
q (0.196)
Panel B: Model (6): v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP + [mu]
Partitions by Firm
Profitability n [b.sub.1] [t.sub.1] [b.sub.2]
q1 (q < 0.001) 2,693 1.38 15.80 -4.57

q2 (0.001 [less than or 2,692 1.31 18.30 3.05
equal to] q < 0.083)
q3 (0.083 [less than or 2,692 1.11 5.70 6.08
q4 (0.134 [less than or 2,692 -0.22 -1.00 15.68
q5 (q [greater than or 2,693 0.78 5.70 11.40
equal to] 0.196)
Partitions by Firm Adj.

Profitability [t.sub.2] [b.sub.3] [t.sub.3] [R.sup.2]
q1 (q < 0.001) -17.80 0.39 1.01 0.10

q2 (0.001 [less than or 2.40 2.76 7.98 ** 0.02
q3 (0.083 [less than or 3.50 1.61 4.46 ** 0.01
q4 (0.134 [less than or 11.80 0.70 2.29 * 0.05
q5 (q [greater than or 27.10 2.38 5.66 ** 0.21
equal to] 0.196)
Panel C: Model (6): v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP

+ [mu] for Subsample of Firms with Similar Segment
Growth Opportunities (n = 2,346)
Partitions by Firm
Profitability n [b.sub.1] [t.sub.1] [b.sub.2]
q1 (q < 0.001) 242 1.46 13.10 -1.02

q2 (0.001 [less than or equal 341 1.09 7.20 3.84
to] q < 0.083)
q3 (0.083 [less than or equal 682 1.07 3.20 5.52
to] q < 0.134)
q4 (0.134 [less than or equal 700 -0.69 -1.25 16.99
to] q < 0.196)
q5 [greater than or equal to] 381 1.08 2.44 11.39
q (0.196)
Partitions by Firm
Profitability [t.sub.2] [b.sub.3] [t.sub.3]
q1 (q < 0.001) -1.52 0.27 0.19

q2 (0.001 [less than or equal 2.49 3.85 5.25 **
to] q < 0.083)
to] q < 0.134)
to] q < 0.196)
q5 [greater than or equal to] 8.66 1.31 0.65
q (0.196)
Partitions by Firm
Profitability Adj. [R.sup.2] Incremental [R.sup.2]
q1 (q < 0.001) 0.002 -0.003

q2 (0.001 [less than or equal 0.05 0.045
to] q < 0.083)
to] q < 0.134)
to] q < 0.196)
q5 [greater than or equal to] 0.19 -0.002
q (0.196)
Incremental [R.sup.2] is the adjusted [R.sup.2] of model (6)

minus the adjusted [R.sup.2] without DOP in model (6).
TABLE 5
Firm Growth Opportunity and the Incremental Value Effect of DOP
Panel A: Descriptive Statistics of Partitions by Analysts'

Forecast of Firm's Long-Term Growth Rate
v q
Partitions by Firm
Growth Std.
Opportunity n Mean Med. Dev. Mean
g1 (g < 8.0) 1,408 1.57 1.47 0.72 0.10

g2 (8.0 [less than or equal to] g 1,408 1.94 1.66 1.18 0.12
< 10.0)
< 12.0)
< 15.0)
g5 (g [greater than or equal to] 1,408 3.79 2.96 3.05 0.15
15.0)
q DOP
Partitions by Firm
Growth Std.
Opportunity Med. Dev. Mean Med.
g1 (g < 8.0) 0.12 0.12 0.03 0.02

g2 (8.0 [less than or equal to] g 0.12 0.12 0.05 0.04
< 10.0)
< 12.0)
< 15.0)
g5 (g [greater than or equal to] 0.15 0.16 0.06 0.04
15.0)
DOP g(%)
Partitions by Firm
Growth Std. Std.
Opportunity Dev. Mean Med. Dev.
g1 (g < 8.0) 0.04 5.37 5.50 2.08

< 10.0)
< 12.0)
< 15.0)
g5 (g [greater than or equal to] 0.06 20.92 20.00 4.97
15.0)
Panel B: Model (6): v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP + [mu]
Partitions by Firm
Growth
Opportunity (%) n [b.sub.1] [t.sub.1] [b.sub.2]
g1 (g < 8.0) 1,408 1.25 44.27 2.59

g2 (8.0 [less than or 1,408 1.22 27.67 5.43
equal to] g < 10.0)
g3 (10.0 [less than or 1,408 1.12 16.01 8.33
equal to] g < 12.0)
g4 (12.0 [less than or 1,408 1.26 17.90 8.57
equal to] g < 15.0)
g5 (g [greater than or 1,408 2.45 20.67 8.34
equal to] 15.0)
Partitions by Firm
Growth Adj.
Opportunity (%) [t.sub.2] [b.sub.3] [t.sub.3] [R.sup.2]
g1 (g < 8.0) 17.69 1.87 4.16 ** 0.18

g2 (8.0 [less than or 25.17 1.90 3.60 ** 0.32
equal to] g < 10.0)
g3 (10.0 [less than or 26.01 3.19 3.97 ** 0.34
equal to] g < 12.0)
g4 (12.0 [less than or 28.37 4.91 7.34 ** 0.39
equal to] g < 15.0)
g5 (g [greater than or 18.59 2.30 2.04 * 0.20
equal to] 15.0)
Panel C: Model (8): v = [b.sub.1] + [b.sub.2][D.sub.M] +

[b.sub.3][D.sub.H] + [b.sub.4]q + [b.sub.5][D.sub.M]q
+ [b.sub.6][D.sub.H]q + [b.sub.7]DOP + [epsilon]
Partitions by Firm
Growth
Opportunity (%) [b.sub.1] [t.sub.1] [b.sub.2] [t.sub.2]
g1 (g < 8.0) 1.15 34.76 -0.46 -1.71

g2 (8.0 [less than or 1.29 27.13 -0.52 -2.14
equal to] g < 10.0)
g3 (10.0 [less than 1.61 27.74 -1.65 -4.55
or equal to] g <
12.0)
g4 (12.0 [less than 1.67 23.78 -1.32 -2.89
or equal to] g <
15.0)
g5 (g [greater than 2.41 19.51 -0.87 -1.41
or equal to] 15.0)
Partitions by Firm
Growth
g1 (g < 8.0) 0.13 1.63 0.28 1.25

g2 (8.0 [less than or -0.73 -6.13 1.40 3.29
equal to] g < 10.0)
g3 (10.0 [less than -1.99 -14.36 -0.85 -1.52
or equal to] g <
12.0)
g4 (12.0 [less than -1.78 -7.97 -0.01 -0.02
or equal to] g <
15.0)
g5 (g [greater than -0.66 -2.07 -1.02 -1.16
or equal to] 15.0)
Partitions by Firm
Growth
g1 (g < 8.0) 6.82 2.93 2.81 6.11

g2 (8.0 [less than or 5.43 2.79 7.89 12.76
equal to] g < 10.0)
g3 (10.0 [less than 14.92 5.84 16.01 21.59
or equal to] g <
12.0)
g4 (12.0 [less than 12.55 4.31 15.54 16.29
or equal to] g <
15.0)
g5 (g [greater than 10.86 2.68 14.19 11.14
or equal to] 15.0)
Partitions by Firm
Growth Adj. Incremental
Opportunity (%) [b.sub.7] [t.sub.7] [R.sup.2] [R.sup.2]
g1 (g < 8.0) 0.98 2.26 * 0.21 0.003

g2 (8.0 [less than or 1.43 2.75 ** 0.47 0.004
equal to] g < 10.0)
g3 (10.0 [less than 2.44 3.92 ** 0.57 0.005
or equal to] g <
12.0)
g4 (12.0 [less than 2.80 4.63 ** 0.51 0.010
or equal to] g <
15.0)
g5 (g [greater than 0.22 0.21 0.36 0.000
or equal to] 15.0)
[D.sub.M] and [D.sub.H] are dummy variables for firms in the

middle and high-third q-value ranges, respectively, in a sample.
Incremental [R.sup.2] is the adjusted [R.sup.2] of model

(8) minus the adjusted [R.sup.2] without DOP in model (8).
TABLE 6
Divergence of Segment Growth Opportunity ([DELTA]g)

and the Incremental Value Effect of DOP
Panel A: Descriptive Statistics of Partitions by Divergence

of Segment Growth Opportunity
v q
Partitions
by Growth St. St.
Divergence n Mean Med. Dev. Mean Med. Dev.
Low [DELTA]g 1,173 3.44 2.82 2.32 0.22 0.20 0.09

Middle [DELTA]g 1,173 3.04 2.47 2.05 0.21 0.18 0.09
High [DELTA]g 1,174 3.46 2.82 2.36 0.23 0.19 0.10
DOP [DELTA]g(%)
Partitions
by Growth St. St.
Divergence Mean Med. Dev. Mean Med. Dev.
Low [DELTA]g 0.05 0.04 0.06 -6.06 5.70 2.65

Middle [DELTA]g 0.06 0.04 0.06 0.00 0.12 1.30
High [DELTA]g 0.05 0.04 0.06 5.36 4.91 2.30
Panel B: Regression Results on the Effect of DOP on Equity Value
[b.sub.1] [t.sub.1] [b.sub.2] [t.sub.2]
Model (5): v =
[b.sub.1] +
[b.sub.2]q + u
Low [DELTA]g -0.31 -2.34 16.79 30.54
Middle [DELTA]g 0.06 0.49 14.19 27.49
High [DELTA]g 0.01 0.09 15.22 29.06
Model (6): v =
[b.sub.1] +
[b.sub.2]q +
[b.sub.3]DOP + u
Low [DELTA]g -0.26 -1.90 16.94 30.48
Middle [DELTA]g 0.03 0.29 13.81 25.34
High [DELTA]g -0.08 -0.59 14.86 27.99
Adj.
[b.sub.3] [t.sub.3] [R.sup.2]
Model (5): v =
[b.sub.1] +
[b.sub.2]q + u
Low [DELTA]g 0.45
Middle [DELTA]g 0.39
High [DELTA]g 0.41
Model (6): v =
[b.sub.1] +
[b.sub.2]q +
[b.sub.3]DOP + u
Low [DELTA]g -1.60 -1.81 * 0.45
Middle [DELTA]g 1.83 2.12 * 0.40
High [DELTA]g 3.23 3.47 ** 0.42
*, ** Denotes significance at the 0.05 (0.01) level, one-tailed.
This table reports the results on the value effect of the difference
in growth opportunities between segments ([DELTA]g) based on firms
with high overall profitability. The data are partitioned into three
equal-sized partitions by [DELTA]g.
[DELTA]g = [[summation of].sub.i] [w.sub.i]([bar]g - [g.sub.i]) +

[[summation of].sub.j] [w.sub.j]([g.sub.j] - [bar]g) is the difference
in growth opportunities between segments, where [g.sub.i] is the growth
opportunity of a segment with profitability less than firm average and
[g.sub.j] is the growth opportunity of a segment with profitability
greater than firm average; [bar]g is the weighted average growth
opportunities of a firm; and [w.sub.i] and [w.sub.j] are weights
defined in terms of segment identifiable assets.
TABLE 7
Divergence of Segment Growth Opportunity ([DELTA]g) and the Incremental

Value Effect of DOP Controlling for Firm Growth Opportunity (g)
Panel A: Descriptive Statistics by Partitions
v q
Partitions
by Growth Std. Std.
Low firm overall

growth opportunity
Low [DELTA]g 554 2.56 2.17 1.53 0.20 0.18 0.08
Middle [DELTA]g 675 2.24 1.95 1.13 0.19 0.17 0.08
High [DELTA]g 530 2.53 2.25 1.30 0.21 0.19 0.08
High firm overall

growth opportunity
Low [DELTA]g 618 4.04 3.42 2.56 0.24 0.21 0.10
Middle [DELTA]g 499 3.84 3.20 2.41 0.23 0.20 0.09
High [DELTA]g 644 3.99 3.25 2.65 0.24 0.20 0.11
DOP [DELTA]g(%)
Partitions
by Growth Std. Std.
Low firm overall

growth opportunity
Low [DELTA]g 0.05 0.04 0.05 -6.01 -5.76 2.55
Middle [DELTA]g 0.05 0.03 0.05 0.05 0.19 1.27
High [DELTA]g 0.05 0.03 0.05 4.91 4.58 1.98
High firm overall

growth opportunity
Low [DELTA]g 0.06 0.04 0.06 -6.10 -5.65 2.72
Middle [DELTA]g 0.06 0.05 0.06 -0.05 -0.03 1.33
High [DELTA]g 0.06 0.04 0.06 5.62 5.14 2.43
Panel B: Regression Results for the Low Firm Overall Growth

Opportunity Partition
Model (5): v =
[b.sub.1] +
[b.sub.2]q + u
Low [DELTA]g -0.18 -1.37 13.48 22.30
Middle [DELTA]g 0.71 7.30 7.94 16.98
High [DELTA]g 0.45 3.38 9.98 16.69
Model (6): v =
[b.sub.1] +
[b.sub.2]q +
[b.sub.3]DOP + u
Low [DELTA]g -0.15 -1.12 13.54 22.18
Middle [DELTA]g 0.71 7.28 7.74 15.54
High [DELTA]g 0.38 2.87 9.74 16.00
Adj.
Model (5): v =
[b.sub.1] +
[b.sub.2]q + u
Low [DELTA]g 0.51
High [DELTA]g 0.39
Model (6): v =
[b.sub.1] +
[b.sub.2]q +
[b.sub.3]DOP + u
Low [DELTA]g -0.82 -0.77 0.51
Middle [DELTA]g 0.88 1.17 0.33
High [DELTA]g 2.55 2.35 ** 0.39
Panel C: Regression Results for the High Firm Overall Growth

Opportunity Partition

Model (5): v =
[b.sub.1] +
[b.sub.2]q + u
Low [DELTA]g -0.01 -0.01 17.06 22.05
Middle [DELTA]g 0.04 0.21 16.60 20.86
High [DELTA]g 0.19 1.10 16.02 23.56
Model (6): v =
[b.sub.1] +
[b.sub.2]q +
[b.sub.3]DOP + u
Low [DELTA]g 0.09 0.43 17.31 22.19
Middle [DELTA]g 0.00 0.01 16.36 19.80
High [DELTA]g 0.11 0.62 15.74 22.82
Adj.
Model (5): v =
[b.sub.1] +
[b.sub.2]q + u
Low [DELTA]g 0.41
High [DELTA]g 0.42
Model (6): v =
[b.sub.1] +
[b.sub.2]q +
[b.sub.3]DOP + u
Low [DELTA]g -2.53 -2.15 * 0.42
Middle [DELTA]g 1.46 1.08 0.43
High [DELTA]g 2.63 2.20 ** 0.43
See the explanatory notes for Table 6.
TABLE 8
Divergence of Segment Growth Opportunity ([DELTA]g) and the Incremental

Value Effect of DOP A Subsample of Two-Segment Firms with Operations in
Two Different Two-Digit SIC Industries
A: Descriptive Statistics of Five Partitions by [DELTA]g

(885 Observations with High Overall Profitability)
v q
Partitions
by Growth Std. Std.
Low [DELTA]g1 177 3.81 3.19 2.21 0.23 0.20 0.10

[DELTA]g2 177 3.11 2.65 1.85 0.21 0.19 0.08
[DELTA]g3 177 3.14 2.22 2.12 0.22 0.18 0.11
[DELTA]g4 177 3.29 2.91 1.75 0.23 0.20 0.10
High [DELTA]g5 177 4.02 3.15 2.40 0.25 0.21 0.12
DOP [DELTA]g(%)
Partitions
by Growth Std. Std.
Low [DELTA]g1 0.03 0.02 0.03 -6.86 -6.25 2.25

[DELTA]g2 0.04 0.02 0.04 -2.04 -1.95 1.01
[DELTA]g3 0.05 0.03 0.05 0.80 0.85 0.63
[DELTA]g4 0.05 0.03 0.05 3.30 3.28 0.77
High [DELTA]g5 0.04 0.02 0.05 6.77 6.16 1.83
B: Regression Results on the Effect of DOP on Equity Value
Model (5): v =
[b.sub.1] +
[b.sub.2]q + u
Low [DELTA]g1 0.30 1.22 14.99 15.64
[DELTA]g2 -0.12 -0.49 15.28 14.01
[DELTA]g3 0.30 1.39 12.89 15.12
[DELTA]g4 0.74 3.46 11.17 13.01
High [DELTA]g5 0.85 3.40 12.42 13.96
Model (6): v =
[b.sub.1] +
[b.sub.2]q +
[b.sub.3]DOP + u
Low [DELTA]g1 0.49 1.90 15.06 15.83
[DELTA]g2 -0.10 -0.36 15.28 14.03
[DELTA]g3 0.28 1.32 12.48 13.49
[DELTA]g4 0.57 2.67 10.85 12.80
High [DELTA]g5 0.71 2.89 11.52 13.12
Adj.
Model (5): u =
[b.sub.1] +
[b.sub.2]q + u
Low [DELTA]g1 0.473
[DELTA]g2 0.442
[DELTA]g3 0.471
[DELTA]g4 0.386
High [DELTA]g5 0.416
Model (6): v =
[b.sub.1] +
[b.sub.2]q +
[b.sub.3]DOP + u
Low [DELTA]g1 -7.15 -2.32 ** 0.495
[DELTA]g2 -0.76 -0.30 0.442
[DELTA]g3 2.26 1.14 0.472
[DELTA]g4 5.25 3.25 ** 0.419
High [DELTA]g5 9.28 4.68 ** 0.470
*, ** Denotes significance at the 0.05 (0.01) level, one-tailed.
This table reports the result on the value effect of the difference
in growth opportunities between segments ([DELTA]g) based on
two-segment firms with two segments operating in different two-digit
SIC industries.
[DELTA]g is defined by Equation (9).
(1) The Association for Investment Management and Research (AIMR) in its position paper (AIMR
1993, 5960) state, "[Segment information] is vital, essential, indispensable, and integral to the
investment analysis process.... Different segments will generate dissimilar streams of cash flows to
which are attached disparate risks and which bring about unique values. Thus, without
disaggregation, there is no sensible way to predict the overall amounts, timing, or risks of a
complete enterprise's future cash flows. There is little dispute over the analytic usefulness of
disaggregated financial data."
(2) SEC enforcement cases demonstrate that regulators take a serious stand in enforcing segment
disclosure rules. On August 15, 1988, for example, the SEC imposed a $1 million penalty on Sony
Corporation for failing to report Sony Pictures as a separate industry segment, but instead reporting
the combined results of Sony Picture and Sony's profitable music business as a single
"entertainment" segment (SEC 1998). This reporting policy obscured the losses sustained by Sony
Pictures. (We thank the associate editor for bringing this to our attention.)
(3) We emphasize the incremental role of segment data in this study because in practice segment
data are reported as additional disclosures to supplement firmlevel financial data. This is
consistent with the incremental usefulness of segment data as emphasized by both users and
standard setters (see, for example, AIMR 1993; AICPA 1994).
(4) Specifically, SFAS No. 131 states that separate reporting of segment information will not add
significantly to an investor's understanding of an enterprise if its operating segments have
characteristics so similar that they can be expected to have essentially the same future prospects
(FASB 1997, 37).
(5) In addition, there are other studies examining issues that are indirectly related to valuation such
as the effect of industry/geographical segment data on investors' expected returns and risk
assessments (see Pactor [1993] for a survey) or on earnings forecast accuracy (Lobo et al. 1998).
(6) See Zhang (2000) for the original version of the model and the details of derivation.
(7) For notational simplicity and where no confusion arises, we omit time subscripts on variables.
(8) For simplicity, we assume away any interactive effect (such as synergy) between segments. Our
results will hold quantitatively even in the presence of such effects. What drives our results is a
feature generic to all multiplesegment firms (with or without synergies), that there exists at least
some degree of independence in operating decisions among segments; it is this independence that
gives rise to segmentlevel real options.
(9) In the empirical analysis below, the definition of DOP is generalized to firms with more than two
segments.
(10) The valuation properties are conveniently illustrated with graphs. Alternatively, the properties
can be shown analytically, but the exposition would be much more complicated. The analytical
derivations are available upon request.
(11) From Equation (2), V/A = [w.sub.1]([V.sub.1/[A.sub.1] + [w.sub.2]([V.sub.2]/[A.sub.2]) where
[V.sub.1]/[A.sub.1] = P([q.sub.1]) + c[q.sub.1] + [g.sub.1]C([q.sub.1]) and [V.sub.2]/[A.sub.2] =
P([q.sub.2]) + c[q.sub.2] + [g.sub.2]C([q.sub.2]) are normalized segment values, and weights
[w.sub.1] = [A.sub.1]/A and [w.sub.2] = [A.sub.2]/A.
(12) Firm profitability q is a weighted average of [q.sub.1] and [q.sub.2], and the normalized firm
value is a weighted average of normalized segment values, where the same set of weights applies
to both averages. A positive value effect of DOP follows from Jensen's Inequality that for a strictly
convex function f(x) and constant [w.sub.1], 0 < [w.sub.1] < 1, we have f([w.sub.1][x.sub.1] + (1
[w.sub.1]) [x.sub.2]) > [w.sub.1] f([x.sub.1]) + (1 [w.sub.1])f([x.sub.2]).
(13) This hypothesis is later shown to hold under more general conditions of nonnegative
correlation between segment profitability and growth opportunity.
(14) This is because as the option moves further into the region of "in the money" or the region of
"out of the money," the likelihood that the option will be exercised becomes less sensitive to
changes in the underlying asset price (the optionholder is more sure about what his eventual
decision will be), and this causes option value to be less convex (i.e., more close to linearity).
(15) The result illustrated in Figure 3 is a general theoretical result. It is confirmed by the simulation
result in Figure 4 below.
(16) In the empirical analysis below, the definition of [DELTA]g is extended to general multiple
segment firms, which takes into account differences in segment size.
(17) Given that segmentlevel equity book values are not reported for the period covered in our
sample (under SFAS No. 14), segmentlevel returns on equity cannot be directly computed. As a
result, return on operating assets is used to measure segment profitability for the purpose of
calculating the divergence of profitability (DOP). An alternative measure of DOP can be constructed
based on imputed segmentlevel returns on equity whereby total liabilities and interest expenses of
a firm are allocated to segments in proportion to segment assets. The two proxies of DOP are
highly correlated (Pearson correlation coefficient = 0.78). Qualitatively similar empirical results are
obtained for the two proxies.
(18) In this more general version, the definition of DOP takes into account (1) the "distance"
between each segment's profitability and the weighted average profitability of the firm and (2) the
asset sizes of segments. Note that for a twosegment firm and given the segments' assets, DOP as
defined in Equation (4) is equivalently represented by [q.sub.2] [q.sub.1] (as in the model in
Section III). In calculating the weights for empirical analysis, we use the sum of identifiable assets
of the firm's segments as denominator, rather than total assets of the firm, because in some cases
identifiable segment assets do not add up to the total assets of the firm (this is also noted in Berger
and Ofek [1995]).
(19) We need to point out that interpretation of growth parameter g is somewhat different between
the model and the empirical setting. In the model, a growth option represents a onetime only
growth for a business; therefore, the size of growth option g should be viewed as the "total growth"
that can be achieved over time. Empirically, on the other hand, g is proxied by the forecasted
annual earnings growth rate, and this annual value normally would be much lower than total
(cumulative) growth potential.
(20) We use singlesegment firms, rather than all firms, in a threedigit SIC industry to match more
closely between the segment being measured and the reference firms and also to avoid introducing
spurious correlation (as singlesegment firms are not in our test samples). Analyst forecasts are
taken four months after the fiscal yearend to reflect possible revisions after the release of financial
statements. Our growth proxy captures growth from positive NPV opportunities to the extent that
analysts forecast earnings growth rates based on their projection of what positive NPV projects will
be available to firms.
(21) Similar truncation procedures are employed in prior studies (e.g., Burgstahler and Dichev
1997; Collins et al. 1999; Barth et al. 1998).
(22) For our overall sample, the Pearson correlation between segment profitability and growth
opportunity is +0.07, significant at the 1 percent level.
(23) Low incremental explanatory power of segment data is also found (or implied) in prior studies,
e.g., Basu et al. (1999) and Givoly et al. (1999), that use different regression specifications. Our
analysis ignores various costs arising in multisegment organizations due to coordination and
communication, loss of managerial focus, crosssubsidization, etc. Such costs may offset to some
extent the value effect of DOP and contribute to low incremental [R.sup.2]s of DOP.
(24) Our result that DOP has an incremental value effect is consistent with Wysocki's (1998) finding
that earnings coefficients differ between profit and loss segments and between high and lowprofit
segments.
(25) For comparison, we apply the same set of cutoff values of profitability for partitioning this
subsample as in Panel B of Table 4. The empirical definition of [DELTA]g is provided below, which
generalizes that in the theoretical model. Also note that requiring analyst forecasts of earnings
growth as growth proxies reduces the overall sample size to 7,040.
(26) The smaller coefficient of DOP for the highest firmlevel growth partition could be due to the
possibility that growth opportunities are more concentrated in relatively lowprofitability segments
for firms within this partition compared with other partitions. As will be shown below, the distribution
of growth opportunities within a firm also matters.
(27) The definition of [DELTA]g here takes into account both the "distance" and the "direction" of
each segment's growth opportunity relative to the average growth opportunity as weighed by
segment assets. It can be shown that this definition is equivalent to [[[A.sub.1][A.sub.2]/([A.sub.1] +
[A.sub.2])].sup.2]([g.sub.2] [g.sub.1]), an expression that arises from analytical derivations to
capture the effect of the divergence in segment growth opportunity.
(28) Results in Table 6 (and also Table 7 below) are based on regression models (5) and (6).
Similar results obtain if models (7) and (8) are used.
(29) We apply onetailed tests for H4 because the hypothesis predicts the direction (sign) of the
value effect of DOP.
(30) Relatedly, Tse (1989) and Wysocki (1998) show that differences in growth opportunity among
segments affect the usefulness of segment data. An insight from our study is that segment growth
opportunities interact with segment profitability in determining value, and one needs to distinguish
the effect of [DELTA]g between high and lowprofitability region.
(31) The estimations here are for illustration only. Our general conclusion does not change if other
reported regression equations are used to compute value changes.
(32) Our results, however, suggest that the estimated economic magnitude attributed to segment
information probably has low precision.
(33) Our study does not consider the costs of operating dissimilar segments in a firm due to, for
example, communication and coordination, loss of management focus, and crosssubsidization.
Such costs can potentially offset some of the predicted value effect of DOP, and this might also
contribute to the low incremental explanatory power.
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We appreciate the comments of Daniel Thornton (Associate Editor), two anonymous referees, and
workshop participants at the Chinese University of Hong Kong, the Hong Kong University of
Science and Technology, and the 2001 HKUST Summer Symposium. We also thank Li Xia for
research assistance. We gratefully acknowledge the financial support from Research Grants
Council of Hong Kong (HKUST6023/00H). All errors are our own.
Editor's note: This paper was accepted by Daniel B. Thornton, Ad Hoc Editor.
Submitted February 2001
Accepted November 2002
Peter F. Chen
Guochang Zhang
Hong Kong University of Science and Technology
Chen, Peter F.^Zhang, Guochang
Citação da fonte (MLA 8a edição)
Chen, Peter F., and Guochang Zhang. "Heterogeneous investment opportunities in multiple
segment firms and the incremental value relevance of segment accounting data." Accounting
Review, Apr. 2003, p. 397+. Academic OneFile,
http://link.galegroup.com/apps/doc/A102105735/AONE?u=capes&sid=AONE&xid=74bbe139.
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Heterogeneous investment opportunities in multiple­segment firms and the incremental

q1 (q < 0.001) 1.0%

Change of Equity Value Attributed

Low [DELTA]g -3.0%

Year n Mean Median Std. Mean

86 993 3.07 1.87 3.59 0.08

Year Median Std. Mean Median Std.

86 0.11 0.18 0.07 0.05 0.08

v is scaled market value, defined as share price three months after

Panel A: Benchmark Model (5): v = [b.sub.1] + [b.sub.2]q + [mu]

Year n [b.sub.1] [t.sub.1]

86 993 2.20 27.00

Year [b.sub.2] [t.sub.2] Adj. [R.sup.2]

86 1.99 4.90 ** 0.02

Panel B: Model (6): v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP + u

Year n [b.sub.1] [t.sub.1] [b.sub.2]

86 993 1.78 16.5 2.47

Year [t.sub.2] [b.sub.3] [t.sub.3] Adj. [R.sup.2]

86 6.06 5.40 5.93 ** 0.06

*, ** Denotes significance at the 0.05 (0.01) level, two-tailed.

[t.sub.i] represents the t-statistic for coefficient [b.sub.i].

Panel A: Benchmark Model (7): v = [b.sub.1] + [b.sub.2][D.sub.M]

Year [b.sub.1] [t.sub.1] [b.sub.2] [t.sub.2] [b.sub.3]

86 1.34 9.20 -0.20 -0.51 -1.44

Year [t.sub.3] [b.sub.4] [t.sub.4] [b.sub.5]

86 -4.39 -4.96 -7.86 10.65

Year [t.sub.5] [b.sub.6] [t.sub.6] Adj. [R.sup.2]

86 3.08 20.29 15.30 0.27

Panel B: Model (8): v = [b.sub.1] + [b.sub.2][D.sub.M]

Year [b.sub.1] [t.sub.1] [b.sub.2] [t.sub.2] [b.sub.3]

86 1.18 7.61 -0.21 -0.54 -1.37

Year [t.sub.3] [b.sub.4] [t.sub.4] [b.sub.5] [t.sub.5]

86 -4.18 -4.57 -7.10 10.60 3.09

86 19.62 14.59 2.20 2.70 ** 0.28

*, ** Denotes significance at the 0.05 (0.01) level, two-tailed.

[D.sub.M] and [D.sub.H] are dummy variables for firms in the

Panel A: Descriptive Statistics of Partitions by Firm's

q1 (q < 0.001) 2,693 2.40 1.14 3.62 -0.22

Partitions by Firm Std. Std.

q1 (q < 0.001) -0.13 0.26 0.11 0.06 0.15

Panel B: Model (6): v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP + [mu]

q1 (q < 0.001) 2,693 1.38 15.80 -4.57

Partitions by Firm Adj.

q1 (q < 0.001) -17.80 0.39 1.01 0.10

Panel C: Model (6): v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP

q1 (q < 0.001) 242 1.46 13.10 -1.02

q1 (q < 0.001) -1.52 0.27 0.19

q1 (q < 0.001) 0.002 -0.003

*, ** Denotes significance at the 0.05 (0.01) level, two-tailed.

[t.sub.i] represents the t-statistic for coefficient [b.sub.i].

Incremental [R.sup.2] is the adjusted [R.sup.2] of model (6)

Panel A: Descriptive Statistics of Partitions by Analysts'

g1 (g < 8.0) 1,408 1.57 1.47 0.72 0.10

g1 (g < 8.0) 0.12 0.12 0.03 0.02

g1 (g < 8.0) 0.04 5.37 5.50 2.08

Panel B: Model (6): v = [b.sub.1] + [b.sub.2]q + [b.sub.3]DOP + [mu]

g1 (g < 8.0) 1,408 1.25 44.27 2.59

g1 (g < 8.0) 17.69 1.87 4.16 ** 0.18

Panel C: Model (8): v = [b.sub.1] + [b.sub.2][D.sub.M] +

g1 (g < 8.0) 1.15 34.76 -0.46 -1.71

g1 (g < 8.0) 0.13 1.63 0.28 1.25

g1 (g < 8.0) 6.82 2.93 2.81 6.11

g1 (g < 8.0) 0.98 2.26 * 0.21 0.003

*, ** Denotes significance at the 0.05 (0.01) level, two-tailed.

Heterogeneous investment opportunities in multiplesegment firms and the incremental