Evolution in Value Relevance of Accounting Information

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Mary E. Bartha
Ken Li
Charles G. McClure

Graduate School of Business

Stanford Universityb

March 2017

We thank Susan Athey, Greg Clinch, Guido Imbens, Bjorn Jorgensen, Lester Mackey, Mary
Tokar, and seminar participants at Cass Business School, Indiana University, London School of
Economics, New York University, and the University of Melbourne for helpful comments and
suggestions.

a
Corresponding author. Email: mbarth@stanford.edu
b
655 Knight Way, Stanford, CA 94305

Electronic copy available at: https://ssrn.com/abstract=2933197

 Evolution in Value Relevance of Accounting Information

Abstract
We find the value relevance of accounting information has increased between 1962 and 2014.
The information we consider comprises twelve accounting amounts plus ten industry indicators.
Regarding individual accounting amounts, we find that operating cash flow, cash holdings, and
two New Economy-related amounts—recognized intangible assets and research and
development expense—increase in value relevance, whereas dividends and, most prominently,
earnings decrease. We also find that more accounting amounts become value relevant, which is
consistent with a more complex relation between equity price and accounting information. There
are marked differences in value relevance of individual accounting amounts for financial,
technology, loss, and profit firms. Our findings are based on a non-parametric approach that
automatically incorporates nonlinearities and interactions, thereby avoiding under-fitting that can
constrain OLS estimation. Because OLS estimation with commonly employed interactions and
nonlinearities overfits the data, thereby overstating value relevance, we measure value relevance
using out-of-sample explanatory power.

JEL classification: C14, G10, G18, M40, M41

Keywords: Capital Markets; Classification and Regression Trees; Equity Valuation; Financial
Reporting; Value Relevance

Electronic copy available at: https://ssrn.com/abstract=2933197

 Evolution in Value Relevance of Accounting Information

1. Introduction

We address four questions relating to the evolution of the value relevance of accounting

information over the last five decades. Has accounting information remained value relevant over

time? Which accounting amounts have increased and decreased in value relevance? Has the

number of accounting amounts that are value relevant increased or decreased? Does this

evolution differ for different types of firms? These are open questions in accounting research.

During this time, the landscape of equity valuation has changed substantially. First, increased

information pertinent to value, including that in financial statements, has enriched the

information environment for investors. Second, the economy has shifted towards more

knowledge-based assets and operations, which are more difficult to quantify and, thus, not

captured well in financial statements. Prior research on the evolution of value relevance of

accounting information largely focuses on the relation between equity price and net income and

equity book value as the two primary accounting summary measures. Several studies find that

that the combined value relevance of equity book value and earnings has decreased over time.

However, other studies indicate that other accounting amounts, such as operating cash flow and

research and development expense, are value relevant incremental to the two summary measures.

The evolution in value relevance of these other accounting amounts together with net income and

equity book value is largely unexplored.1 This is the focus of our study.

Given prior research finds that accounting amounts other than net income and equity

book value are value relevant and a richer disclosure landscape in recent decades, investors

1
Throughout, we use the terms net income and earnings interchangeably.
likely incorporate more information in their valuations over time. Accounting amounts other

than earnings and equity book value likely reflect at least some of this information. Our analyses

focus on the evolution in the value relevance of a set of accounting amounts, including but not

limited to earnings and equity book value, which allows us to identify trends in the value

relevance of these accounting amounts together and individually, and reveals changes in the

complexity of the relation between equity price and accounting information. It also allows us to

assess whether the decrease in value relevance of earnings reported in prior research is offset by

a net increase in value relevance of other accounting information.

The approach we use to address our research question has four main features. First, we

focus on annual relations between equity price and twelve accounting amounts and ten industry

indicators. Focusing on annual relations provides evidence regarding the evolution of the

relation. The accounting amounts include earnings and equity book value, which have well-

established associations with equity price; accounting amounts likely to reflect information

pertinent to valuing “New Economy” firms, i.e., firms whose value derives primarily from

intangible assets; and other accounting amounts prior literature finds are value relevant. Second,

our value relevance metric is the explanatory power from out-of-sample estimation of the

relation (OOS R2). OOS R2 is a more accurate measure of explanatory power in the presence of

over-fitting, which can be substantial in Ordinary Least Squares (OLS) value relevance

estimations that include nonlinearities and interactions. Third, we base our key inferences on

findings from classification and regression trees (CARTs) estimation. CARTs is a non-

parametric approach that is less susceptible to over-fitting than OLS estimation even though it

automatically incorporates important nonlinearities and interactions, which avoids under-fitting

that can constrain OLS estimation. This is an attractive feature of CARTs because a large

2
literature suggests that such nonlinearities and interactions exist but their precise nature is

unknown. Fourth, we disaggregate the OOS R2 to determine the value relevance contribution of

each accounting amount and how its contribution changes over time.

We estimate the annual value relevance relations from 1962 to 2014. We estimate three

specifications using OLS. First, we estimate the relation with only net income and equity book

value, as in prior research. We do not find that the value relevance of these two amounts has

decreased over time; we find no significant decreasing or increasing trend. Second, we estimate

the relation with the twelve accounting amounts and industry indicators. We find that value

relevance increases significantly over time and is significantly higher than that for the

specification with net income and equity book value alone. Third, we estimate a version of the

second specification that includes nonlinearities and interactions commonly employed in prior

research. We find that this specification substantially overfits the relation in that its out-of-

sample value relevance is less than that of the specification with net income and equity book

value alone. Thus, we do not consider it further. Fourth, we estimate the relation with the

twelve accounting amounts and industry indicators using CARTs. As expected, given its flexible

form, this specification reveals largest value relevance. It also reveals that value relevance has

increased over time.

We also find significant changes in the value relevance of individual accounting amounts.

Consistent with prior literature, we find that earnings becomes significantly less value relevant,

and equity book value becomes significantly more value relevant. In addition, we find that

operating cash flow and cash holdings increase in value relevance and dividends decrease.

Recognized intangible assets and research and development expense, the two amounts most

pertinent to New Economy firms, increase in value relevance. These findings, together with the

3
significant increase in value relevance for the set of accounting amounts and industry indicators

are consistent with the net increase in value relevance of other accounting amounts offsetting the

decrease in the value relevance of earnings.

Disaggregation of OOS R2 reveals that more accounting amounts become value relevant

over time. For example, in 1962 only earnings contributed more than ten percent of the OOS R2.

In 2014, earnings, equity book value, operating cash flow, and research and development

expense all contributed more than ten percent. We interpret the increase in the number of

accounting amounts that contribute substantially to explaining equity price as consistent with the

relation between equity price and accounting information becoming more complex.

We next investigate whether the evolution of value relevance differs across types of

firms. We examine four firm types: (1) financial firms, because their valuations and operations

are different from the rest of the economy and they often are excluded from, or studied

separately in, much of accounting research, (2) technology firms, because they are representative

of New Economy firms, (3) loss firms, because their valuations are not well understood, and (4)

profit firms, the complement of loss firms. Regarding financial firms, we find that the value

relevance of dividends is higher than that in the full sample, and remains value relevant over

time. Regarding technology firms, we find a decrease in the value relevance of earnings, and a

much greater increase in the value relevance of cash flows, cash holdings, and recognized

intangible assets, relative to the full sample. Regarding loss firms, we find that, as one would

expect, earnings has little value relevance. Instead, equity book value, assets, and cash holdings

are the most value relevant accounting amounts. The low value relevance of earnings for loss

firms may explain the overall decrease in the value relevance of earnings for the full sample

because the fraction of loss firms has increased significantly over time. Regarding profit firms,

4
earnings is the most value relevant accounting amount, and its value relevance has decreased

more slowly than in the full sample.

Our study contributes to the value relevance literature by describing the evolution of the

relation between equity price and accounting information. Overall, we find that the value

relevance of accounting information does not decrease over time. We find that although the

value relevance of earnings has decreased, that decrease is more than offset by the net increase in

value relevance of other accounting amounts. In addition, we find that more accounting amounts

become value relevant, which is consistent with a more complex relation between accounting

information and equity price. We also contribute to the literature by applying an estimation

technique to mitigate issues in estimation specifications commonly used in accounting research,

which we show can result in over- and under-fitting and incorrect inferences regarding

explanatory power of estimated relations. We also show that the technique we use can address

these issues and obtain the best fit between equity price and the accounting amounts.

The remainder of the paper proceeds as follows. Section 2 explains how our study relates

to prior research, and section 3 develops the research design. Section 4 describes the sample and

data, section 5 presents the findings, and section 6 presents additional tests. Section 7 provides a

summary and concluding remarks.

2. Related Literature

Several studies examine the value relevance of accounting information over time using

OLS estimation. Collins, Maydew, and Weiss (1997) and Francis and Schipper (1999) study

value relevance of equity book value and earnings, and do not find a decrease in combined value

relevance, but find that the value relevance of earnings decreases and that decrease is offset by

an increase in value relevance of equity book value. Brown, Lo, and Lys (1999) also finds that

5
the value relevance of earnings decreases and that of equity book value increases, but finds a

decrease in combined value relevance. Lev and Zarowin (1999) and Balachandran and

Mohanram (2011) also find a decreasing trend in the combined value relevance of earnings and

equity book value. Lev and Gu (2016) considers a larger set of accounting amounts—assets,

liabilities, earnings, sales, cost of sales, and selling, general, and administrative expense—and

finds a decrease in value relevance of accounting information.2

Prior research also finds that earnings quality has decreased, and suggests the decrease in

earnings quality could explain the decrease in value relevance of earnings. One explanation

prior research offers for the decrease in earnings quality is the rise of the New Economy, in

which firm value derives primarily from intangible assets. Lev and Zarowin (1999) finds a

weaker association between equity price and equity book value and earnings for firms with more

intangible assets, measured by the equity market-to-book ratio. The study attributes this finding

to the mismatch in the timing of the recognition of expenses and revenues associated with

intangible assets. Srivastava (2014) finds that the decrease in earnings quality is attributable to

the recent increase in the number of new firms with business models focused on intangible

assets.

Another explanation is changes in accounting standards that result in lower quality

earnings. For example, earnings becomes less value relevant because earnings include more

one-time, or non-persistent, items. Consistent with this example, Collins, Maydew, and Weiss

(1997) finds that the decrease in value relevance of earnings does not apply when the study’s

tests include controls for one-time items. Dichev and Tang (2008) finds a decrease in the

2
Collins, Maydew, and Weiss (1997), Brown, Lo, and Lys (1999), Lev and Zarowin (1999), and Balachandran and
Mohanram (2011) deflate amounts by number of shares outstanding, as do we. Francis and Schipper (1999) deflates
by equity book value. Lev and Gu (2016) use undeflated amounts.

6
contemporaneous correlation between revenues and expenses, and concludes that accounting

matching has decreased. Bushman, Lerman, and Zhang (2016) finds little association between

accruals and cash flow in recent years and attributes this finding to the timing mismatch between

revenues and expenses.3

A large literature also suggests that accounting amounts other than earnings and equity

book value are value relevant.4 For example, Aboody and Lev (1998) finds that capitalized

software development cost is associated with stock returns incremental to earnings and equity

book value, and Core, Guay, and Van Buskirk (2003) finds that research and development

expense is incrementally associated with equity market value. Barth, Beaver, Hand, and

Landsman (1999) finds that separating earnings into accruals and cash flow increases the

explanatory power of value relevance regressions. Given a richer set of disclosures over the last

five decades, it is possible that the decrease in value relevance of earnings is offset by an

increase in value relevance of other accounting information, which motivates us to study a larger

set of accounting amounts.5

Because we incorporate in our tests several accounting amounts in addition to net income

and equity book value, we use a more flexible estimation technique than OLS. Prior research

typically estimates a linear regression of earnings and equity book value, which has theoretical

3
An explanation for the decrease in value relevance of accounting amounts is increased noise in equity prices that is
uncorrelated with equity book value or net income. This increase in noise in equity price could be indicative of a
decrease in accounting quality. Core, Guay, and Van Buskirk (2003) finds that value relevance of earnings and
equity book value decreases between 1996 and 1999, and posits that the decrease has less to do with the New
Economy, and more to do with an increase in the variance of price, and returns, that is unrelated to accounting
information. Dontoh, Radhakrishnan, and Ronen (2004) posits that the decrease in value relevance of accounting
information is exacerbated by the increased presence of noise traders, which can cause greater deviations between
equity price and fundamental value. Regardless, as section 5 explains, we find an increase in value relevance.
4
See Holthausen and Watts (2001) and Barth, Beaver, and Landsman (2001) for summaries of this literature.
5
Examples of additional information in financial reports are the introduction of cash flow statement in SFAS 95 in
1987 and updates to intangibles accounting standards in SFAS 142 in 2001. Investors obtain value relevant
information from a wide variety of sources and access to that information also has been expanding in recent years.

7
underpinnings in the Ohlson (1995) framework. However, Holthausen and Watts (2001)

observes that much of the existing value relevance literature omits nonlinearities from its

analysis, and other research posits and finds nonlinearities and interactions in the relation

between equity price and accounting amounts. For example, regarding the analytical literature,

Riffe and Thomson (1998) shows that the relation between price and earnings (book value of

equity) can be nonlinear when earnings (book value of equity) captures economic earnings (book

value of equity) with error. Yee (2000) extends Ohlson (1995) and shows that a nonlinear

relation between price and earnings can exist when firms adapt to their competitive environment.

However, Riffe and Thompson (1999) and Yee (2000) observe that the models are not

comprehensive and, thus, the identified nonlinearities likely are not the only ones that exist.

Regarding the empirical literature, Collins, Pincus, and Xie (1999) finds a flat relation

between earnings and equity price for loss firms, but a positive relation for profit firms. Barth,

Beaver, and Landsman (1998) finds that valuation coefficients on earnings and equity book value

differ as a function of firms’ financial health. Faulkender and Wang (2006) finds that financially

constrained firms have higher marginal value of cash holdings. In addition, a substantial

literature examines the explanatory power of various financial ratios, which are nonlinear

transformations of accounting amounts (e.g., Ou and Penman, 1989). Motivated by the findings

in these studies, and the lack of a comprehensive theory for which nonlinearities and interactions

to include in the relation between equity price and accounting amounts, we use an estimation

approach that automatically determines the nonlinearities and interactions needed to obtain the

best fit. As a result, the approach enables us to learn to a greater extent which accounting

information explains equity price.

8
 Our study also is related to the growing literature on how the qualitative disclosure

landscape has changed over time. Li (2008) finds the lengths of the Management Discussion and

Analysis section and footnotes have substantially increased from 1994 to 2003, and Dyer, Lang,

and Stice-Lawrence (2016) finds that the median text length of Forms 10-K has increased from

23,000 words in 1996 to nearly 50,000 words in 2013. Hope, Hu, and Lu (2016) finds that risk-

factor disclosures with a high level of specificity have capital market effects that could cause

market participants to adjust their interpretation of accounting information. To the extent that

qualitative disclosures help market participants interpret accounting information, our tests of

changes in the value relevance of individual amounts could reflect how disclosure has changed.

3. Research design

3.1 Accounting information

We focus our analyses on a set of twelve accounting amounts that prior research

identifies as value relevant and are available over our sample period—1962 to 2014. We include

earnings and equity book value because, as section 2 explains, they are the focus of prior

research investigating trends in value relevance of accounting information. We include

operating cash flow, cash holdings, and dividends as cash-related firm characteristics because

there is an extensive literature linking cash and valuation (e.g., Barth, Beaver, Hand, and

Landsman, 1999). We include research and development expense, recognized intangible assets,

and advertising expense as New Economy accounting amounts (e.g., Aboody and Lev, 1998;

Core, Guay, and Van Buskirk, 2003). We include special items and other comprehensive

income, given their increased focus from both academics and regulators in recent years (e.g.,

Jones and Smith, 2011). Finally, we include total assets and revenue as two additional key

accounting amounts from the statements of financial position and income.

9
3.2 Value relevance over time

We assess intertemporal trends in value relevance of accounting information by focusing

on the relation between equity price and accounting amounts and estimate the relation by year.

We begin by estimating equation (1).

𝑃𝑖 = 𝛽0 + 𝛽1 𝑁𝐼𝑖 + 𝛽2 𝐵𝑉𝐸𝑖 + 𝜀𝑖 (1)

𝑃 is equity price, 𝑁𝐼 is earnings, and 𝐵𝑉𝐸 is book value of equity. We measure equity price

three months after fiscal year-end to ensure the accounting information is publicly available.

Equation (1) includes only net income and book value of equity, both deflated by shares

outstanding, to facilitate comparison with directly related prior research (e.g., Collins, Maydew,

and Weiss, 1997; Brown, Lo, and Lys, 1999; Lev and Zarowin, 1999; Balachandran and

Mohanram, 2011). Subscript i indexes firms; we omit year subscripts. Appendix 2 includes

definitions for all variables. We refer to equation (1) as Basic OLS.

To assess the combined value relevance of more accounting information and industry

effects, we estimate equation (2), which includes twelve accounting amounts plus ten industry

indicator variables:

𝑃𝑖 = 𝛽0 + 𝛽1 𝑁𝐼𝑖 + 𝛽2 𝐵𝑉𝐸𝑖 + 𝛽3 𝐶𝐹𝑖 + 𝛽4 𝐶𝐴𝑆𝐻𝑖 + 𝛽5 𝐷𝐼𝑉𝑖 + 𝛽6 𝑅𝐷𝑖 (2)

+ 𝛽7 𝐼𝑁𝑇𝐴𝑁𝑖 + 𝛽8 𝐴𝐷𝑉𝑖 + 𝛽9 𝑆𝑃𝐼𝑖 + 𝛽10 𝑂𝐶𝐼𝑖 + 𝛽11 𝑅𝐸𝑉𝑖

10

+ 𝛽12 𝐴𝑆𝑆𝐸𝑇𝑆𝑖 + ∑ 𝛽13,𝑗 𝐼𝑁𝐷10𝑗𝑖 + 𝜀𝑖

𝑗=1

𝐶𝐹 is operating cash flow, 𝐶𝐴𝑆𝐻 is cash holdings, 𝐷𝐼𝑉 is dividends to common shareholders,

𝑅𝐷 is research and development (R&D) expense, 𝐼𝑁𝑇𝐴𝑁 is recognized intangible assets,

including capitalized software, 𝐴𝐷𝑉 is advertising expense, 𝑆𝑃𝐼 is special items, 𝑂𝐶𝐼 is other

comprehensive income, 𝑅𝐸𝑉 is revenue, and 𝐴𝑆𝑆𝐸𝑇𝑆 is total assets, all deflated by shares

10
outstanding. 𝐼𝑁𝐷10 is a set of indicator variables for the Fama-French ten industry groups. We

refer to equation (2) as 22-OLS.

Next, we estimate equation (3), which includes the 22 variables in equation (2) plus

interactions between each of the twelve accounting amounts and the ten industry indicator

variables and LOSS, which is an indicator variable that equals one if the firm reports negative NI,

and zero otherwise (e.g., Balachandran and Mohanram, 2011). Thus, equation (3) includes

interactions commonly included in prior research either explicitly or implicitly, e.g., by

estimating equation (2) by industry. We refer to equation (3) as Full OLS.

10 10 12

𝑃𝑖 = 𝛽0 + 𝛽1 𝐿𝑂𝑆𝑆𝑖 + ∑ 𝛽2𝑗 𝐼𝑁𝐷10𝑗𝑖 + ∑ ∑ 𝛽3𝑗𝑘 𝐼𝑁𝐷10𝑗𝑖 ×𝑉𝐴𝑅𝑘𝑖

𝑗=1 𝑗=1 𝑘=1
(3)
10 12

+ ∑ ∑ 𝛽3𝑗𝑘 𝐼𝑁𝐷10𝑗𝑖 ×𝑉𝐴𝑅𝑘𝑖 ×𝐿𝑂𝑆𝑆𝑖 + 𝜀𝑖

𝑗=1 𝑘=1

With the potential for nonlinearities and interactions in the underlying data, OLS is

susceptible to under-fitting. Under-fitting occurs when the estimation method is not sufficiently

flexible to capture the underlying relation (Hastie, Tibshirani, and Friedman, 2001). OLS is

susceptible to under-fitting because it assumes an additively linear structure in explanatory

variables, unless the researcher explicitly specifies particular nonlinearities and interactions.

Although equation (3) permits some nonlinearities and interactions, more are possible. When

unspecified interactions and nonlinearities exist, OLS cannot accommodate these relations and

thus has lower explanatory power than a more flexible method.

To mitigate under-fitting, we estimate equation (4) using CARTs to estimate the value

relevance of the twelve accounting amounts and ten industry indicator variables; we refer to

equation (4) as CARTs.

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 𝑃𝑖 = 𝐶𝐴𝑅𝑇(𝑉𝐴𝑅𝑖 , 𝐼𝑁𝐷10𝑖 ) (4)

𝐶𝐴𝑅𝑇 is CARTs function and 𝑉𝐴𝑅 is the vector of the twelve accounting amounts. Appendix 1

explains CARTs estimation. In brief, CARTs is a nonparametric method that recursively

partitions over the space of explanatory variables to identify nonlinearities in the underlying

relation of interest and interactions between and among the explanatory variables.6 By relaxing

the assumed linear and additive structure of OLS, CARTs estimation is less subject to under-

fitting than is OLS estimation.

OLS also is susceptible to over-fitting when there are many explanatory variables relative

to the number of observations. With many explanatory variables, the estimation essentially

reflects the particular characteristics of the in-sample data rather than the underlying relation.

Thus, if the researcher removes a few observations, re-estimates the OLS equation using the

remaining observations, and uses the resulting coefficient estimates to predict the price of the

removed observations, the predictive power of the OLS equation would be poor.7 Over-fitting

can cause estimates of value relevance based on in-sample adjusted R2 to be biased upward

(Hastie, Tibshirani, and Friedman, 2001), and can cause value relevance of a seemingly more

comprehensive equation to be less than that of a simpler equation. Out-of-sample explanatory

power, OOS R2, reveals over-fit equations because the equations perform poorly on out-of-

sample observations. Thus, we use OOS R2 as our value relevance metric.

6
CARTs is part of a family of decision tree-based estimation methods that can increase explanatory power relative
to traditional linear methods, detect relative importance of explanatory variables, and uncover nonlinearities and
interactions in the marginal relations underlying the explanatory variables and the outcome (Breiman, 2001). These
methods are used in a variety of research settings outside of accounting and finance, e.g., facial recognition, spam e-
mail detection, and disease diagnosis (see Verikas, Gelzinis, and Bacauskiene, 2011 for a review of this literature).
7
To illustrate over-fitting, consider a yearly estimation with observations from 5,000 firms. To explain variation in
share price, the researcher can add accounting amounts and interaction terms on the right-hand side of the estimation
equation until the equation includes 5,000 explanatory variables. An OLS estimation of the relation between share
price and the 5,000 explanatory variables will yield an in-sample R2 of 1.0. However, it is unlikely that this
equation describes the underlying relation between price and the explanatory variables.

12
 CARTs addresses over-fitting by bootstrapping the sample, estimating a tree over each

bootstrapped sample, using the tree from each bootstrapped sample to predict price for the out-

of-sample observations, comparing the out of-sample price predictions, averaged across

bootstrapped samples, with actual prices to estimate explanatory power and, thus, goodness-of-

fit. Fitting the equation using only a portion of the observations in each bootstrapped estimation

and averaging estimates of predicted price reduces noise in the estimated underlying relation.8

CARTs generates only an OOS R2, there is no metric analogous to in-sample R2 for CARTs.

Thus, to test for a change in value relevance across years, we estimate equation (5).

𝑂𝑂𝑆𝑅2𝑡 = 𝛽0 + 𝛽1 𝑌𝐸𝐴𝑅𝑡 + 𝜀𝑡 (5)

𝑂𝑂𝑆𝑅2 is the out-of-sample R2, OOS R2, and 𝑌𝐸𝐴𝑅 is the data year, i.e., 1962,…, 2014. t

denotes year. We estimate equation (5) separately for OOS R2s from equations (1) through (4).

We estimate OOS R2 using ten-fold cross-validation for equations (1) through (3) and out-of-bag

cross validation for equation (4).9 If an equation indicates accounting information has become

more (less) value relevant over time, then 𝛽1 is positive (negative).

3.3 Value relevance of individual accounting amounts

8
Although CARTs estimation can provide new insights into the intertemporal and cross-sectional trends in value
relevance, it has several limitations. First, although CARTs automatically determines the nonlinearities and
interactions to include in the estimation equation, it is difficult to visualize all relations in the estimated CART
prediction function. Therefore, we consider partial relations only for a subset of accounting amounts and a subset of
years. Thus, even though we can uncover some underlying relations, our tabulated findings and figures do not
summarize all significant relations underlying the CART prediction function. Second, the approach does not permit
us to summarize our findings in the form of parsimonious coefficient estimates and confidence intervals as is the
case for OLS estimations. Several of our findings provide nonlinear functional form estimates. Although we can
summarize these relations using averages of the coefficient estimates, these averages do not fully describe the
underlying relations without visualization.
9
In ten-fold cross-validation, we randomly partition the data into ten equal-sized parts. For each part, we estimate
the equation using data from the other nine parts while holding out the tenth, and use the estimated equation to
predict the price of the held-out observations. We repeat this for all ten parts, so that we hold out each part from
estimation once. The sum of the mean squared price prediction error for observations of the held out parts, scaled
by the variance of price, is the ten-fold cross validation estimate of OOS R2 (Hastie, Tibshirani, and Friedman,
2001). We use out-of-bag cross-validation for equation (4) because it is the standard cross-validation methodology
for CARTs. An observation is out-of-bag for trees that did not draw it in the bootstrapping. Footnote 16 reports that
our inferences are unaffected by using ten-fold cross-validation for CARTs.

13
 We next disaggregate the OOS R2 from equation (4) to measure the relative importance

of each accounting amount. We determine which accounting amounts have become more or less

value relevant over time by estimating equation (6) for each amount. We base equation (6) on

estimates from equation (4) because CARTs is less susceptible to under-fitting than OLS and,

thus, enables the underlying value relevance of the accounting amounts to manifest. In addition,

CARTs is less susceptible to over-fitting, which enables it to handle nonlinearities and

interactions in the underlying relation.

𝑉𝐴𝑅𝐼𝑀𝑃𝑘𝑡 = 𝛽0 + 𝛽1 𝑌𝐸𝐴𝑅𝑡 + 𝜀𝑡 (6)

𝑉𝐴𝑅𝐼𝑀𝑃𝑘 is accounting amount 𝑘’s relative importance. If an accounting amount has become

relatively more (less) important over time, then 𝛽1 is positive (negative). We interpret an

increase (decrease) in relative importance of a particular accounting variable as an increase

(decrease) in the amount’s value relevance.

We measure 𝑉𝐴𝑅𝐼𝑀𝑃𝑘 as how much of total decrease in explanatory power if all

variables were randomly assigned one at a time is attributable to accounting amount 𝑘. Thus,

𝑉𝐴𝑅𝐼𝑀𝑃𝑘 captures how much the OOS R2 would decrease if accounting amount 𝑘 is omitted

from the equation, which provides a direct measure of its importance relative to the other

accounting amounts. For example, if we randomly assign variable 𝑋1 and the resulting OOS R2

is less than when we randomly assign 𝑋2, then we consider 𝑋1 as relatively more important than

𝑋2.10 This metric is analogous to incremental R2.

To estimate the number of important amounts over time, we estimate equation (7):

10
For example, assume there are two variables, NI and BVE. Assume the total explanatory power of the two
variables together is 0.90. Assume that if NI (BVE) is randomly assigned, the explanatory power is 0.30 (0.70),
which means that when NI (BVE) was randomly assigned the explanatory power decreased 0.60 (0.20), i.e., 0.90 –
0.30 (0.90 – 0.70). Thus, the variable importance of NI is 0.75, i.e., 0.60/(0.60 + 0.20), and that of BVE is 0.25, i.e.,
0.20/(0.60 + 0.20). In CARTs, we randomly assign one variable at a time to assess its importance, except for the
industry indicators, for which we randomly assign all ten indicators at a time.

14
 𝐼𝑀𝑃𝑡 = 𝛽0 + 𝛽1 𝑌𝐸𝐴𝑅𝑡 + 𝜀𝑡 (7)

𝐼𝑀𝑃 is the number of important accounting amounts in year 𝑡, which is the number of

accounting amounts with more than 1, 2, 3, 5, or 10 percent contribution to OOS R2.11 We

interpret an increase (decrease) in the number of important accounting amounts over time as an

increase (decrease) in the complexity of the relation between equity price and accounting

information.

3.4 Cross-sectional differences in value relevance

We next estimate equation (4) separately for four types of firms to evaluate cross-

sectional differences in the evolution of value relevance of accounting information. These types

are financial, technology, loss, and profit firms. Financial firms are in the Fama-French 48

industries of banking (44), insurance (45), and trading (47).12 Following Francis and Schipper

(1999) and Core, Guay, and Van Buskirk (2003), technology firms are in three-digit SIC

industries that have large unrecorded intangible assets (i.e., industries 283, 357, 360-368, 481,

737, and 873), which includes computer hardware and software, pharmaceuticals, electronic

equipment, and telecommunications. Loss firms have net income less than zero, and profit firms

are the complement of loss firms. For these estimations, we use data beginning in 1971 to ensure

a sufficiently large sample for each year for each firm type.

4. Sample and Data

Our full sample consists of 227,289 firm-year observations in the intersection of

Compustat and CRSP from 1962 to 2014. We begin in 1962 because that is the year Compustat

began its service. Although Compustat backfilled data prior to 1962, the data reflect selection

11
We use five thresholds because there is no standardized threshold for tests of variable importance. Using five
thresholds allows us to analyze trends in value relevance for various thresholds.
12
This definition is similar to that in Dhaliwal, Subramanyam, and Trezevant (1999), which defines financial firms
as those in SIC industries 6400-6499 and 6600-6999.

15
bias and coverage is tilted towards historically successful firms (Fama and French, 1992;

Linnainmaa and Roberts, 2016). Untabulated statistics reveal that our sample includes 27.6

percent loss firms, 15.5 percent financial firms, and 20.0 percent technology firms.13 We impose

minimal sample requirements to obtain a comprehensive sample of firms. Specifically, we

require that firms be listed on NYSE, NASDAQ, or AMEX, and have non-missing net income,

book value of equity, equity price, shares outstanding, assets, lagged assets, revenue, and SIC

industry code.14 If a firm has missing operating cash flow, we use the balance sheet approach of

Sloan (1996) to estimate it.15 If a firm is missing any other accounting amount, we set the

amount to zero. We winsorize all accounting amounts at the 1st and 99th percentiles, by year, to

mitigate the impact of outliers on estimation results.

Table 1 provides descriptive statistics and correlations for the twelve accounting amounts

and equity price. Our sample covers a large percentage of Compustat/CRSP firms, and

descriptive statistics for our sample are similar to those in prior literature. Panel A shows that

mean equity price, P, is 18.89, which is slightly higher than mean price of 16.98 and 17.58

reported in Brown, Lo, and Lys (1999) and Collins, Maydew, and Weiss (1997). This higher

mean reflects a higher average equity price in recent years. The mean (median) earnings per

share, NI, is 0.90 (0.66), which is lower than the mean earnings per share of 1.10 (0.80) and 1.29

(0.95) reported in Brown, Lo, and Lys (1999) and Collins, Maydew, and Weiss (1997). These

lower amounts reflect an on-average decrease in earnings in recent years.

13
Untabulated statistics also reveal that the proportion of financial firms increases in the sample period at a rate of
0.4 percent per year (t-stat. = 28.10), and the proportion of loss firms increases at an average rate of 0.7 percent per
year (t-stat. = 11.72). The proportion of technology firms increases from the beginning of the sample period to
2000, the height of the technology bubble, and drops subsequently, with an average rate of increase of 0.3 percent
per year (t-stat. = 11.07) over the entire sample period.
14
We require firms have lagged assets to ensure prior year financial statements are included in Compustat because
several variables, such as other comprehensive income, require prior year financial statements to compute.
15
Sloan (1996) estimates accruals using balance sheet information by taking differences in current assets and current
liabilities. We estimate cash flow as net income less estimated accruals for firms with missing cash flow data.

16
 Table 1, panel B, reports correlations between the variables. Regarding correlations with

equity price, equity book value has the largest Pearson (Spearman) correlation of 0.63 (0.73) and

is closely followed by net income with correlation of 0.61 (0.72). Research and development

expense has a positive Pearson (Spearman) correlation with equity price of 0.23 (0.03), which is

consistent with the expense reflecting future economic value (e.g., Lev and Sougiannis, 1996).

5. Findings

5.1 Value relevance over time

Table 2 presents findings from estimating goodness-of-fit for Basic OLS, 22-OLS, Full

OLS, and CARTs, i.e., equations (1) through (4). For each specification, panel A presents the

yearly goodness-of-fit statistics and the mean across years. Panel B presents findings from tests

of differences in the mean goodness-of-fit between various combinations of specifications, and

reveals that all differences are significant (t-stats. range from 3.19 to 28.42 in absolute value).

Panel A, columns 1 and 2, reveals that for Basic OLS the mean in-sample adjusted R2 is

55.9 percent, and the mean OOS R2 is 55.7 percent, a difference of –0.2. Panel A, columns 3 and

4, show that for 22-OLS, the mean in-sample adjusted R2 (OOS R2) is 64.4 (63.5) percent. The

difference between the mean in-sample and OOS R2 for 22-OLS is –0.9. The mean in-sample

adjusted R2 and mean OOS R2 for 22-OLS are significantly higher than those of Basic OLS, by

8.5 and 7.8. These findings are consistent with accounting information other than net income

and equity book value and industry indicators being incrementally significantly value relevant.

Panel A, column 5, shows that the mean in-sample adjusted R2 for Full OLS is 70.3

percent. Comparing the mean in-sample R2 for Basic OLS and Full OLS, i.e., columns 1 and 5,

would suggest that Full OLS has significantly higher explanatory power (difference = 14.4).

However, column 6 reveals that the OOS R2 for Full OLS is 44.1 percent, which is significantly

17
lower than its mean in-sample adjusted R2, i.e., columns 5 and 6, (difference = –26.3), and lower

than the OOS R2 for Basic OLS, i.e., columns 2 and 6, (difference = –11.7). Thus, Full OLS

substantially over-fits the relation. It also is unclear from this comparison whether the

accounting amounts other than earnings and equity book value provide incremental explanatory

power in OLS estimation. This is because the OOS R2 for Full OLS is lower than that of 22-

OLS, 44.1 versus 63.5, which indicates that adding commonly employed nonlinearities and

interactions results in over-fitting. The findings relating to Full OLS reveal that researchers

should exercise caution in incorporating nonlinearities and interactions in OLS estimation. The

risk of over-fitting and, thus, incorrect inferences regarding explanatory power is nontrivial.

Panel A, column 7, reveals that CARTs yields the highest mean OOS R2 of 68.3 percent.16

Panel B reveals that, on average, 22-OLS has a 7.8 percent higher OOS R2 than Basic

OLS, i.e., columns 4 and 2, (63.5 versus 55.7).17 This difference suggests that incorporating

accounting amounts other than earnings and equity book value improves value relevance. Panel

B also reveals that, on average, CARTs has a 4.8 percent higher OOS R2 than 22-OLS, i.e.,

columns 4 and 7, (68.3 versus 63.5), which suggests that incorporating nonlinearities and

interactions for the same set of 22 accounting amounts and industry indicators improves value

relevance.18 To determine how much of the 4.8 percent improvement in OOS R2 is attributable

16
Because CARTs is estimated over bootstrapped samples, the in-sample R2 for CARTs is not well-defined. Thus,
for CARTs we report only OOS R2. The OOS R2 performance of CARTs is not sensitive to the cross-validation
methodology to estimate OOS R2. Although our OOS R2 for CARTs is estimated using out-of-bag cross-validation,
we also use ten-fold cross-validation to estimate OOS R2 for CARTs, consistent with the cross-validation
methodology for the OLS based models. We find that the mean OOS R 2 for CARTs using ten-fold cross-validation
is 68.1 percent, which is an insignificantly lower than the 68.3 percent OOS R 2 using out-of-bag cross-validation
and a two-tailed paired t-test (t-stat. = –1.20).
17
We omit Full OLS from this analysis because its mean OOS R2 is lower than that of Basic OLS.
18
Although CARTs has the highest mean value relevance of our estimation methods, one concern regarding CARTs
is that it may over-fit the relation in early sample years—CARTs has lower OOS R2 than Basic OLS or 22-OLS for
several early years. Thus, we use Random Forests as an alternative to CARTs, which better controls for over-fitting
(see Appendix 1). Untabulated findings reveal that Random Forests has higher OOS R 2 than Basic OLS in every

18
to nonlinearities and how much is attributable to interactions, we estimate OOS R2 using a

generalized additive model (GAM), which is a non-parametric estimation method that permits

nonlinearities but not interactions.19 Untabulated findings reveal that the mean GAM OOS R2

across all years is 65.3 percent, which is 1.8 percent higher than the OOS R2 of the 22-OLS

model (t-stat. = 2.13) and 3.0 percent lower than the OOS R2 of the CARTs model (t-stat. =

4.66). These findings, together with those in table 2, panel B, reveal that NI and BVE alone yield

an OOS R2 of 55.7 percent, including the additional accounting amounts and industry indicators

adds 7.8 percent, including nonlinearities adds 1.8 percent, and including interactions adds 3.0

percent, for a total mean OOS R2 of 68.3 percent using CARTs (68.3 = 55.7 + 7.8 + 1.8 + 3.0).20

Figure 1 plots the OOS R2 for Basic OLS, 22-OLS, and CARTs.21 Table 2, panel A,

reports that CARTs has the largest OOS R2. This is followed by the 22-OLS OOS R2, which in

turn is larger the Basic OLS OOS R2. Figure 1 shows that Basic OLS exhibits a substantial

decrease in value relevance during the technology bubble in the late 1990s, which is consistent

with the findings in Balachandran and Mohanram (2011). In 1999, the Basic OLS OOS R2 is

12.2 percent, whereas it averaged 50.0 percent in the six adjacent years, which represents a

decrease of 37.8 percent.

year and higher OOS R2 than 22-OLS in all years except 1964, which is consistent with Random Forests better
controlling for over-fitting in earlier years of our sample than CARTs. Untabulated statistics based on Random
Forests estimation also reveal the same inferences revealed by the statistics in table 2, panel C regarding
intertemporal trends in value relevance.
19
Hastie and Tibshirani (1986) develops GAMs. We use the Wood (2011) implementation of GAMs and use cross-
validation to select smoothness parameters.
20
That net income and equity book value explain 55.7 percent of the variation in share price and CARTs, with
twelve accounting amounts, explains 68.3 percent should not be interpreted as indicating that the variables other
than net income and equity book value, and their interactions, explain only 12.6 percent of the variation in price.
The other variables are correlated with net income and equity book value. Inspection of figure 4 below reveals that
in recent years the other variables together explain approximately the same variation in price as do net income and
equity book value.
21
Because Full OLS produces highly variable estimates of OOS R2, we do not include it for comparison in figure 1
and table 2.

19
 With the inclusion of the additional accounting amounts and industry indicators,

nonlinearities, and interactions using CARTs, the decrease in value relevance during the

technology bubble is less pronounced. The 1999 OOS R2 is 40.1 for CARTs, whereas it

averaged 66.7 percent in the six adjacent years, which represents a decrease of 26.6 percent.

This smaller decrease for CARTs than for Basic OLS is consistent with a stronger relation during

this period between equity price and accounting information other than earnings and equity book

value, rather than with accounting information being irrelevant. It also is consistent with

nonlinearities and interactions between and among accounting amounts becoming more

important during this time. Based on the statistics presented in table 2, panel A, this importance

continues after the technology bubble. Specifically, over the last five (ten) years, 2009 to 2014

(2004 to 2014), for CARTs the untabulated mean value relevance is 70.5 (71.2) percent, which is

higher than the mean of 68.3 percent over the full sample period. These statistics indicate that in

recent years, the value relevance of accounting information is higher than it has been historically.

Table 2, panel C, reports the trend of OOS R2 based on estimating equation (5). Row (1)

reveals that Basic OLS has a positive trend in OOS R2 of 0.057 percent per year, but the trend is

not significant (t-stat. = 0.60). Rows (2) and (3) reveal that 22-OLS and CARTs have

significantly increasing trends in OOS R2; 22-OLS is 0.189 percent per year and CARTs is 0.254

percent per year (t-stats. = 2.34 and 3.18). These findings are consistent with the value relevance

of accounting information increasing, not decreasing, over time. Row (4) reveals that the

difference in the explanatory power of CARTs and Basic OLS increases, on average, by 0.198

percent per year (t-stat. = 5.32). This finding is consistent with accounting amounts other than

20
equity book value and net income, nonlinearities, and interactions becoming more important in

the relation between equity price and accounting information.22

We disaggregate this incremental difference in explanatory power into contributions of

accounting amounts other than book value of equity and net income, and of nonlinearities and

interactions. Row 5 of panel C reveals that the trend in the difference in explanatory power

between CARTs and 22-OLS is 0.065 percent per year, which is significantly different from zero

(t-statistic = 3.35). This finding is consistent with the value relevance of nonlinearities and

interactions in the relation between price and accounting information significantly increasing

over time. Row 6 of panel C reveals that the trend in the difference in explanatory power

between 22-OLS and Basic OLS is 0.132 percent per year, which also is significantly different

from zero (t-statistic = 5.26). This finding is consistent with accounting amounts other than

equity book value and earnings having a stronger relation with equity price over time. Taken

together, the rows 5 and 6 statistics reveal that additional accounting amounts and nonlinearities

and interactions both become more important in the relation between equity price and accounting

information. The trend in row 6 is twice that in row 5 (0.132 versus 0.065), which suggests that

two-thirds of the increasing trend in OOS R2 of CARTs over Basic OLS is attributable to

including additional accounting amounts, and one-third is attributable to incorporating into the

estimation equation nonlinearities and interactions.

We find that value relevance of accounting information increases from 1962 to 2014 and

is higher, on average, in the most recent five and ten years than for entire sample period.

However, inspection of figure 1 reveals that examining different sub-periods can result in finding

22
Our findings in table 2, panel C, are robust to controlling for the technology bubble. In untabulated tests, we
follow the approach in Balachandran and Mohanram (2011) and include an additional indicator variable that equals
one from 1998-2000, the three years with the lowest OOS R2, and zero otherwise. The untabulated findings reveal a
direction and significance similar to that in table 2, panel C.

21
value relevance increases, decreases, or is unchanged. Thus, to reconcile our findings to prior

research that finds decreasing value relevance of net income and equity book value, we re-

estimate Basic OLS and CARTs using observations from 1975 to 2004, which is the sample

period in Balachandran and Mohanram (2011). Untabulated statistics reveal a significantly

negative coefficient on YEAR of –0.573 percent (t-stat. = –2.43) for Basic OLS and –0.345

percent (t-stat. = –2.03) for CARTs. Thus, it is possible that prior research finds a decrease in

value relevance because the sample periods in those studies end close to the technology bubble,

during which value relevance was unusually low, as revealed by figure 1.

Figure 2 presents the marginal relation to price as estimated by CARTs for selected

accounting amounts for five years: 1975, 1985, 1995, 2005, and 2014. We do not do so for all

accounting amounts and all years because it is difficult to graph and concisely summarize such a

large number of relations. Regardless, these graphs provide insights into the functional forms of

the marginal relation between each accounting amount and equity price.

Figure 2, panel A, presents the marginal relation between earnings and equity price and

shows that in all years the slope is flat for negative earnings and positive for positive earnings,

which is consistent with there being little marginal relation between earnings and equity price for

negative earnings firms. Panel A shows that the shape of the marginal relation between net

income and price in becoming increasingly nonlinear. For example, in 1975 the marginal

relation between price and positive earnings was moderately positive and relatively linear.

However, in later years, the “kink” at zero earnings is more pronounced as there is a larger slope

for positive earnings. Also, another nonlinearity appears in these later years as the marginal

relation between earnings and price seems to flatten at amounts with large values of net income.

22
The nonlinear evolution in the marginal relation of net income and price could explain why prior

literature finds a sharp decrease in value relevance of earnings based on a linear model.

Panel B reveals little marginal relation between operating cash flow and equity price for

negative cash flow firms in that, as with earnings in panel A, the marginal relation is essentially

flat when operating cash flow is negative, but positive when operating cash flow is positive. To

our knowledge, this finding is new to the literature.23 There appears to be little marginal relation

between operating cash flow and equity price prior to the introduction of the statement of cash

flows with SFAS 95 in 1987 (i.e., 1975 and 1985). In the years following SFAS 95, the marginal

relation between positive cash flow firms and price gradually becomes more pronounced as the

slope becomes steeper. Panel C (D) reveals a fairly linear marginal relation between book value

of equity (dividends) and equity price. This suggests that linear regressions could well

approximate the marginal relations between these amounts and price.

Figure 3 plots the marginal relation between accounting information and equity price with

several interactions for 2014. Panel A reveals that cash holdings has a significantly larger

marginal relation with equity price for non-dividend paying than dividend paying firms. This

finding is consistent with the marginal value of cash being higher for financially constrained

firms (Faulkender and Wang, 2006). Panel B partitions firms with and without R&D expense,

and reports the marginal relation between dividends and equity price for these two sets of firms.

Firms that pay dividends and have non-zero R&D expense have a lower marginal relation

between price and dividends than firms with no R&D expense. R&D expense typically suggests

the firm has growth prospects, whereas dividends imply the return of excess cash to

23
Standard financial statement analysis textbooks, such as Palepu and Healy (2008), suggest that earnings- and cash
flow-based multiples are less useful when they are temporarily low, which is consistent with a stronger marginal
relation between cash flow and prices for positive cash flow firms.

23
shareholders. Thus, if R&D expense and dividends are substitute uses for cash, this finding

suggests the marginal relations differ because firms that do both have less persistent dividends.

Panel C shows that there is little difference in the marginal relations between price and

R&D expense for technology and non-technology firms, except for high R&D expense. This

finding suggests that, despite the label, technology and non-technology firms have returns to

research and development that appear to not differ substantially. However, untabulated statistics

reveal that the difference is significant.24 Except for the difference in slope in the marginal

relation between earnings and equity price at zero earnings, the nonlinearities are not captured by

Full OLS because these nonlinearities and interactions are not specified. Collectively, figures 2

and 3 reveals relations consistent with even Full OLS under-fitting the data by not specifying all

of the nonlinearities and interactions in the underlying relation.

5.2 Changes in value relevance of individual accounting amounts

Figure 4 presents the relative contributions of each accounting amount to the CARTs

goodness-of-fit, and table 3 tests for changes over time in variable importance. Table 3, panel A,

presents estimates of coefficient, 𝛽1, from equation (6), for each accounting amount. The

coefficient for net income, NI, is –0.730 percent (t-stat. = –11.21), which indicates that the

relative importance of earnings significantly decreases over the sample period. In contrast, the

coefficient for equity book value, BVE, is 0.402 percent (t-stat. = 5.98), which indicates that the

relative importance on equity book value significantly increases over the sample period. This

increase in the importance of equity book value and decrease in the importance of earnings is

24
In untabulated analysis, for each panel, we assess the difference between the average slopes over the common
support, i.e., largest 2.5% and smallest 97.5% quantile between the two subsamples. We find that the difference in
slopes in each panel is different at the 5% level based on a 500 bootstrapped sample-based test.

24
consistent with the findings in Collins, Maydew, and Weiss (1997) and Brown, Lo, and Lys

(1999).

Regarding the three cash-based accounting amounts, panel A reveals that operating cash

flow and cash holdings, CF and CASH, significantly increase in relative importance at average

annual rates of 0.249 and 0.099 percent (t-stats. = 9.91 and 3.91), and that dividends, DIV,

significantly decrease at an average annual rate of –0.120 percent (t-stat. = –4.93). Figure 4

shows that during the technology bubble, the relative importance of net income and equity book

value decrease substantially and that of cash holdings increases substantially. These patterns are

consistent with operating cash flow and cash holdings becoming more value relevant and

dividends becoming less value relevant.

Regarding New Economy accounting amounts, panel A reveals that intangibles, INTAN,

and research and development expense, RD, significantly increase in relative importance at

average annual rates of 0.043 and 0.058 percent (t-stats. = 8.08 and 3.02), but that of advertising

expense, ADV, does not. Panel A also reveals that the relative importance of special items

significantly increases at a rate of 0.035 percent (t-stat. = 5.41), but that of OCI does not (t-stat. =

0.05).25 In addition, panel A reveals that the relative importance of revenue, assets, and industry

indicators has not changed significantly (t-stats. = 0.12, –1.50, and 0.08).26

25
Untabulated descriptive statistics reveal that the variability of special items and OCI increase over time, which is
consistent with greater usage of these items, but only special items evidence an increase in value relevance. Jones
and Smith (2011) finds that special items have greater predictive power for forecasting future earnings than OCI,
based on a sample from 1976-2005.
26
Figure 4 reveals that the two years for which industries have the highest value relevance are 1979, the year of the
second oil crisis, and 1999, at the height of the technology bubble. In untabulated tests, we disaggregate the variable
importance of industries by individual industry. The findings reveal that in 1979 Fama-French industry 4, the oil
and gas industry, makes up 69.5 percent of the total variable importance of the ten individual industries, which
suggests that accounting amounts reflect price differently for oil and gas firms from other firms during the oil crisis.
The findings also reveal that in 1999 Fama-French industries 5 and 6, high-technology and telecom industries, make
up 90.8 percent of the total variable importance of the ten individual industries, which is consistent with high-
technology firms and telecom firms having accounting amounts that reflect price differently from other firms at the
height of the technology bubble.

25
 Table 3, panel B, presents estimates of 𝛽1 from equation (7), which evaluates changes in

the number of important accounting amounts over time. Panel B reveals an increase in the

number of important accounting amounts over time, with coefficients based on importance

threshold levels of 1, 2, 3, 5, and 10 percent of 0.092, 0.076, 0.041, 0.021, and 0.023 (t-stats.

range from 2.29 to 9.50).27

Overall, the findings in table 3 are consistent with a more complex relation between equity

price and accounting information over time in that an increasing number of accounting amounts

are important in explaining equity price. The findings also are consistent with operating cash

flow, cash holdings, and New Economy-related accounting amounts becoming more value

relevant, and earnings and dividends becoming less value relevant.

5.3 Cross-sectional trends in value relevance

Table 4 and figures 5, 6, and 7 present findings for select subsamples of firms. Table 4,

panel A, presents the average relative importance rank across years for each accounting amount

and the rank-ordering based on this average importance measure. Column 1 presents the

variable importance order for the full sample. That ordering reveals that despite a significantly

decreasing trend in importance, net income, NI, is the most value relevant accounting amount

27
The findings in table 3, panels A and B, are based on CARTs because CARTs yields the largest explanatory
power of the three estimation methods we consider. 22-OLS is second largest. Consistent with CARTs’ superior
performance, untabulated findings analogous to those in table 3, panel A, based on 22-OLS reveal five differences
from CARTs: cash holdings and research and development expense exhibit no significant trend for 22-OLS,
whereas CARTs finds that they exhibit increasing trends; dividends exhibit no trend for 22-OLS, whereas CARTs
finds it exhibits a decreasing trend; assets exhibit an increasing trend for 22-OLS, whereas CARTS finds it exhibits
no trend; and revenue exhibits a decreasing trend for 22-OLS, whereas CARTs finds it exhibits no trend.
Untabulated findings analogous to those in table 3, panel B, based on 22-OLS reveal the same inferences as those
based on CARTs in that both 22-OLS and CARTs find an increase in number of important variables over time for
all thresholds.

26
over the sample period with an across-year average rank of 1.09. Equity book value is the

second most relevant with an average rank of 2.55.28

Regarding financial firms, column 2 presents the variable ordering and reveals that NI is

also the most relevant accounting amount for financial firms. The relative importance of

dividends for financial firms is significantly higher than for the full sample, with an average rank

of 3.48 (rank = 3) compared to 5.57 (rank = 5) for the full sample. Other comprehensive income,

OCI, is relatively more important for financial firms than for other firms, with a rank of 8; its

rank is 12 or 13 for the full sample and the other three subsamples.29 As one might expect,

research and development expense, RD, is least important for financial firms, with a rank of 12.

Regarding technology firms, column 3 presents the variable ordering and reveals that operating

cash flows, CF, cash holdings, CASH, and intangibles, INTAN, are relatively more important for

technology firms, with average ranks of 5.52, 5.48, and 9.95, compared to average ranks of 7.09,

7.32, and 10.98 for the full sample. In contrast to financial firms, dividends, DIV, are relatively

unimportant for technology firms, with an average rank of 8.00 compared to 5.57 for the full

sample.

Regarding loss firms, column 4 presents the variable ordering and reveals that earnings,

NI, has little importance, with average rank of 9.27 compared to 1.09 for the full sample. In fact,

loss firms is the only group in table 4 for which earnings is not ranked first. Equity book value,

BVE, assets, ASSETS, and cash holdings, CASH, three balance sheet based accounting amounts,

28
The full sample includes observations from 1962 to 2014, whereas data availability limits us to using observations
from 1971 to 2014 for the subsample analyses. Untabulated findings for the full sample over the sample period
beginning in 1971 reveal a ranking of important variables similar to that in table 4, panel A. The untabulated
maximum absolute difference in average ranks is 0.39, and the untabulated rank order is the same except that the
orders of RD and CF are reversed, 8 and 6 versus 6 and 8 in panel A.
29
The finding for DIV is consistent with practitioners recommending the dividend discount model to value banks
(e.g., Damodaran, 2009). The finding for OCI is consistent with the Dhaliwal, Subramanyam, and Trezevant (1999)
finding that comprehensive income is more value relevant for financial firms than for non-financial firms.

27
are the most value relevant variables for loss firms, with average ranks 1.50, 2.75, and 4.45,

compared to 2.55, 3.26, and 7.32 for the full sample. That equity book value is most important

for loss firms could explain the increase in value relevance of equity book value for the full

sample because the proportion of loss firms increased significantly over time. Column 5 reveals

that in contrast to loss firms, profit firms have rankings similar to the full sample.

Table 4, panel B, presents estimates of the coefficient on 𝛽1 from equation (6) for each

accounting amount. Column 1 presents trends in value relevance for financial firms and reveals

that no significant change in the relative importance of dividends (t-stat. = –1.36), compared to a

significant decrease for the full sample. The increases in value relevance of cash flows, cash

holdings, and research and development expense, also are less pronounced for financial firms

than for the full sample.

Column 2 of panel B presents trends in value relevance for technology firms. It reveals

that cash holdings and operating cash flow become significantly more important at average

annual rates of 0.283 and 0.683 (t-stat. = 3.91 and 6.99), which is significantly higher than

average annual rates of 0.099 and 0.249 for the full sample. Figure 5 reveals that they are

especially important during the technology bubble and in more recent years. In particular, cash

holdings has higher relative importance than net income in 1998 and 1999, and operating cash

flow has higher variable importance than net income in four of the five most recent years. Panel

B also reveals that intangibles significantly increase in importance at an average rate of 0.090 (t-

stat. = 5.62), which is significantly higher than for the full sample.

Columns 3 and 4 of panel B present trends in value relevance for loss and profit firms.

Regarding loss firms, net income shows no significant trend in importance (t-stat. = 1.45),

compared to a significant decrease for the full sample. Book value of equity decreases in value

28
relevance at an average annual rate of –0.576 percent (t-stat. = –2.92), compared to an increase

for the full sample. Regarding profit firms, net income decreases in value relevance at an

average annual rate of –0.496 (t-stat. = –5.47), but the decrease is significantly less pronounced

for profit firms than for the full sample, which is consistent with net income remaining more

value relevant for profitable firms.

Taken together, table 4 reveals significant variation over time in the importance for value

relevance of each accounting amount for different types of firms. Reliable evidence regarding

the importance of each accounting amount is possible because we use CARTs estimation.

Without knowing ex ante the complexity of the relation between equity price and the accounting

amounts, including how the relations change over time, it would be difficult to obtain this

evidence with OLS-based estimation.

6. Additional tests

6.1 Constant sample

We estimate variable importance for the subsample of 340 firms that survive from 1971

to 2014. Table 5 and figure 8 present the value relevance rankings and trends. For this

subsample, we find that earnings is the most value relevant accounting amount. In addition,

earnings has no significant trend in value relevance with a coefficient of 0.106 per year (t-stat. =

0.72), compared to a decrease of –0.730 per year in the full sample (t-stat. = –11.21). All firms

in this subsample survive for at least 43 years, which suggests that they have improving or strong

long-term fundamental performance. Thus, these findings indicate that earnings is highly value

relevant for these firms, and remains value relevant over time.

6.2 Lifecycle stage

29
 We follow Dickinson (2011) to identify firms by lifecycle stage, based on their operating,

investing, and financing cash flows.30 Untabulated findings reveal that mature firms, i.e., firms

with positive operating cash flows and negative investing and financing cash flows, have trends

in value relevance similar to profit firms. In particular, earnings is the most value relevant

accounting amount, and remains more value relevant than for the full sample over time. In fact,

as with the constant sample, earnings exhibits no significant trend (t-stat. = –0.46). All other

trends in value relevance for mature firms are in the same direction as those for profit firms. For

declining firms, i.e., firms with negative operating cash flows and positive investing cash flows,

equity book value has higher value relevance than earnings, similar to loss firms. This is

consistent with the abandonment option hypothesis, which suggests that at least some of these

firms are valued at liquidation values (e.g., Hayn, 1995; Berger, Ofek, and Swary, 1996; Joos

and Plesko, 2005).

7. Conclusion

We examine the evolution in value relevance of accounting information and find that

over time more accounting amounts become value relevant. We base our inferences on the non-

parametric classification and regression trees estimation approach, which determines the

nonlinearities in the relation between equity price and the accounting amounts, and interactions

between and among the accounting amounts necessary to provide improved out-of-sample

estimation of equity price. This is important because a large literature suggests that such

nonlinearities and interactions exist but their precise nature is unknown. In addition, the more

30
The Dickinson (2011) approach requires operating, investing, and financing cash flows. We estimate missing
Compustat operating cash flows following Sloan (1996), as described in section 4. We estimate missing investing
cash flows as change in noncurrent assets, plus depreciation. We estimate missing financing cash flows as change in
noncurrent liabilities, plus change in debt included in current liabilities, plus change in shareholders’ equity less
change in retained earnings, less dividends.

30
traditional OLS estimation is ill-equipped to handle multiple nonlinearities and interactions

because it over-fits the data. In addition, these relations can change over time. Thus, our

inferences rely on findings from annual estimations of the relation between equity price and

accounting information.

We find that twelve accounting amounts are consistently able to explain cross-sectional

variation in equity price over time, which indicates accounting information remains value

relevant. We also find significant changes in value relevance of individual accounting amounts

over time, and an increase in the number of accounting amounts that substantially contribute to

explaining equity price. On average for the broad economy, operating cash flow, cash holdings,

and New Economy-related accounting amounts become more value relevant, and earnings and

dividends become less value relevant. We also find significant variation in value relevance of

individual accounting amounts for particular types of firms. Specifically, we find that for

financial firms, dividends are more value relevant than in the full sample, and for technology

firms, research and development expense, cash holdings, and recognized intangibles have higher

value relevance than in the full sample. We also find that for loss firms, earnings have little

relevance, whereas for profit firms, earnings are highly value relevant and exhibit a substantially

less pronounced decreasing trend than for the full sample.

Our study contributes to the literature by describing how the relation between equity

price and accounting information has evolved. Overall, we find that the explanatory power of

accounting information for equity price has increased over time, not decreased. We also find

that more accounting amounts become value relevant over time and different accounting

amounts are value relevant for different types of firms. Our findings are consistent with a more

complex relation between accounting information and equity price, not a decreasing relation.

31
32
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35
APPENDIX 1: Classification and Regression Trees (CARTs) estimation
This appendix describes the classification and regression trees (CARTs) method we use to
nonparametrically estimate the relation between accounting amounts and equity price. We refer
to this as CARTs (Hastie, Tibshirani, and Friedman, 2001; Brieman, 2001; Liaw and Wiener,
2002).
We first provide a simple example that illustrates the CART estimation process and how it
identifies interactions and nonlinearities. Consider a data set with six observations of net
income, equity book value, and equity price:
Observation # Net income Equity book value Equity price
1 1 1 1
2 2 1 2
3 3 1 3
4 1 2 11
5 2 2 12
6 3 2 16

In this data set, equity book value has a large effect on equity price, and for firms with equity
book value of 1, the relation between net income and price is linear, whereas for firms with
equity book value of 2, the relation between net income and price is nonlinear.
CARTs segments the space of explanatory variables into simple regions. CARTs begins with the
single region of the entire space of explanatory variables that contains all observations, and the
CART prediction function predicts the average price of all observations. The first plot below
shows the six points, and the initial CART prediction function, which predicts a price of 7.5 for
all input values of net income and equity book values.

CARTs next divides the space of explanatory variables into rectangular regions by splitting the
initial region based on a split value of one of the explanatory variables. After the split, the
predicted price in each of the two sub-regions created by the split is the average of the response
variables in the sub-region. CARTs selects the explanatory variable and split value that
minimizes the residual sum of squares in the two sub-regions after the split to perform the split.
Initially, the residual sum of squares is

36
 (1 − 7.5)2 + (2 − 7.5)2 + (3 − 7.5)2 + (11 − 7.5)2 + (12 − 7.5)2 + (16 − 7.5)2 = 197.5
Searching over all possible splits of net income and equity book value, the split that provides the
largest reduction in mean squared error is splitting firms on equity book value into two regions,
with the first region containing firms with equity book value of 1 and the second region
containing firms with equity book value of 2. This divides the first three observations into one
region, and the last three observations into a second region. The predicted prices in each region
are the averages of the prices in the region, which are 2 and 13. The residual sum of squares is
(1 − 2)2 + (2 − 2)2 + (3 − 2)2 + (11 − 13)2 + (12 − 13)2 + (16 − 13)2 = 16
The reduction in residual sum of squares along this split is 197.5 – 16 = 181.5. This is the largest
reduction in residual sum of squares possible among all possible split values on both equity book
value and earnings, so this is the chosen split.

Further splits subdivide existing regions into sub-regions, based on the same criterion that
minimizes residual sum of squares. Thus, the second split is on earnings, and divides
observations 4 and 5 into one region and observation 6 into a second region.

The next three additional splits create one region for each observation.

37
We observe that the CART prediction function now captures nonlinearities in earnings for
observations with equity book value of 2. The CART prediction function also captures the
interaction between equity book value and earnings because for observations with equity book
value of 1, the CART prediction function predicts a linear relation between earnings and equity
book value, which is different from the nonlinear relation between earnings and price for
observations with equity book value 2.31
More formally, let 𝑃 be a vector of observed prices and 𝑉𝐴𝑅 be a matrix of observed
explanatory variables. Let 𝑗 index explanatory variables and 𝑖 index observations. We perform
recursive binary partitioning to split the space of explanatory variables into regions 𝑅1 and 𝑅2 :

𝑅1 (𝑗, 𝑠) = {𝑉𝐴𝑅|𝑉𝐴𝑅𝑗 < 𝑠}

𝑅2 (𝑗, 𝑠) = {𝑉𝐴𝑅|𝑉𝐴𝑅𝑗 ≥ 𝑠}

by choosing the explanatory variable 𝑉𝐴𝑅𝑗 and the split value 𝑠 that minimizes the residual sum
of squares,
2 2
∑ (𝑃𝑖 − 𝑃̂𝑅1 ) + ∑ (𝑃𝑖 − 𝑃̂𝑅2 )
𝑖:𝑉𝐴𝑅𝑖 ∈𝑅1 (𝑗,𝑠) 𝑖:𝑉𝐴𝑅𝑖 ∈𝑅2 (𝑗,𝑠)

Within each of region, we make the same prediction for all observations in that region, which is
the average value of the outcome variable in that region, or 𝑃̂𝑅1 and 𝑃̂𝑅2 .

Subsequent splits choose the variable and split value that splits one existing region into two sub-
regions, again choosing the variable and split value that minimizes the residual sum of squares.
We require a minimum of five data points in each region and successive splits are made until any
additional split results in fewer than five data points in a region.

31
In this illustration, each region has only one observation. In our implementation, we follow Hastie, Tibshirani,
and Friedman (2001) and require each region have a minimum of five observations for each bootstrapped tree.
Furthermore, while not apparent in this illustration, CARTs can re-use variables for splits after using other variables.
For example, if CARTs first split by book value, and then earnings, it can use book value again for subsequent
splits.

38
When we apply CARTs estimation to our data, we first bootstrap the data 500 times, drawing
bootstrapped samples of the same sample size as the true sample. Each time, we draw from the
true sample with replacement, which creates bootstrapped samples that contain on average 63.2
percent of the unique observations in the true sample (Hastie, Tibshirani, and Friedman, 2001).
We then generate a regression tree for each bootstrapped sample. The predicted value is the
average of the predicted values of each regression tree.
An alternative estimation technique, Random Forests, follows implementation identical to
CARTs, except that at each split, the set of candidate variables that can be selected to split the
data is a random subset of the explanatory variables, where the number of candidate variables
equals the square root of the number of explanatory variables rounded down to the nearest
integer and the random selection is redone at each split (Hastie, Tibshirani, and Friedman, 2001).
We calculate variable importance of an individual variable as the increase in mean squared error
of the out-of-bag data averaged over all bootstrapped samples, when CARTs uses randomly
permuted values of the variable, rather than the original CARTs.32 A particular observation is
out-of-bag for trees that did not draw it in bootstrapping draws. We scale the variable
importance measure by the sum of the increase in mean squared error of the out-of-bag data of
all variables, to obtain its relative share of variable importance.
We base the marginal relation plot for variable of interest 𝑥 and the outcome on:
𝑁
1
𝑓̂(𝑥) = ∑ 𝑓̂(𝑥, 𝒛𝒊 )
𝑁
𝑖=1

where 𝑁 is the number of observations in the sample of interest, and 𝒛𝒊 is the vector of other
predictors for observation 𝑖, and 𝑓̂(𝑥) is the estimated CART prediction function. The marginal
relation plot is generated by evaluating 𝑓̂ over the range of 𝑥 and graphing the resulting 𝑓̂(𝑥) at
each 𝑥. In the numerical example, if earnings is the variable of interest 𝑥, and let 𝑓̂(𝑥, 𝑦) denote
the estimated CART prediction function based on the six observations where 𝑦 is book value,
then we have:
1
𝑓̂(1) = (𝑓̂(1,1) + 𝑓̂(1,1) + 𝑓̂(1,1) + 𝑓̂(1,2) + 𝑓̂(1,2) + 𝑓̂(1,2))
6
1
= (1 + 1 + 1 + 11 + 11 + 11) = 6
6
Similar calculations finds 𝑓̂(2) = 7 and 𝑓̂(3) = 9.5. To plot the marginal relation in figures 2
and 3, we take the minimum 𝑓̂ (i.e., 𝑓̂(1) = 6), and subtract that amount from each of the three
values of net income as follows:

32
The variable importance of industries is the drop in explanatory power if all industries were randomly permuted.

39
40
APPENDIX 2: Variable definitions

Variable Definition (Source)

Share price
P Share price three months after fiscal year-end (Compustat prcc_q)
Accounting amounts
NI Earnings divided by number of shares (Compustat ib/csho)
BVE Book value of equity per share at fiscal year-end (Compustat ceq/csho)
Cash flow per share (Compustat oancf/csho). If missing, we estimate this as
earnings less accruals, where accruals is defined as (change in current assets
CF (act) less change in cash (che)) less (change in current liabilities (lct) less
change in short term debt (dlc) less change in income taxes payable (txp)),
scaled by number of shares, consistent with Sloan (1996).
CASH Cash and cash equivalents per share (Compustat che/csho)
DIV Dividends per share (Compustat dvc/csho)
RD Research and development expenses per share (Compustat xrd/csho)
INTAN Intangible assets per share (Compustat intan/csho)
ADV Advertising expense per share (Compustat xad/csho)
SPI Special items per share (Compustat spi/csho)

Other comprehensive income per share, calculated as retained earnings (re)

OCI
less lagged retained earnings plus dividends (dvc) less earnings (ib), scaled by
shares (csho) (Dhaliwal, Subramanyam, and Trezevant, 1999) (Compustat)
REV Revenue per share (Compustat revt/csho)
ASSETS Assets per share (Compustat at/csho)
Industries
IND10
Fama-French 10 industries membership (CRSP/Kenneth French Data Library)
Other
The number of accounting amounts with more than 1 percent, 2 percent, 3
IMP percent, 5 percent, or 10 percent variable importance.
Indicator variable equal to 1 if the firm has less than zero net income, and 0
LOSS otherwise
Out-of-sample R2, estimated using ten-fold cross-validation for OLS based
OOSR2 models and out-of-bag estimates for CARTs. Refer to Appendix 1.
Variable importance of a particular accounting amount, based on share of total
decrease in OOS R2 of random assignment of individual accounting amounts.
VARIMP Refer to Appendix 1.
YEAR Fiscal year (Compustat fyear)

41
FIGURE 1: Goodness-of-fit

This figure graphs the goodness-of-fit statistics in table 1. The y-axis represents the out-of-
sample R2 and the x-axis represents year. The data points are the out-of-sample (OOS) R2
values. The trendlines are the fitted linear regression lines of the OOS R2 values over time.
Basic OLS is an estimate of a specification of price on earnings and equity book value, based on
equation (1). 22-OLS is an estimate of a specification of price on twelve accounting amounts
and Fama-French 10 industry indicators, based on equation (2). CARTs estimates a
nonparametric specification of equity price on accounting amounts and Fama-French 10 industry
groups as specified in equation (4). Basic OLS, 22-OLS, and CARTs data points correspond to
the OOS R2 values for Basic OLS, 22-OLS, and CARTs in columns 2, 4, and 7 of table 2.

42
FIGURE 2: Marginal relations between accounting amounts and equity price
Panel A: Earnings

Panel B: Operating cash flow

43
Panel C: Book value of equity

Panel D: Dividends

This figure presents the marginal relation between accounting amounts and equity price, for
select accounting amounts in 2014, 2005, 1995, 1985, and 1975. The x-axis is the accounting
amount of interest which is net income, cash flow from operations, book value, and dividends for
panels A, B, C, and D, respectively. The support for the x-axis is set such that the lower bound
is the value of the 2.5 percent quantile of the year with the largest 2.5 percent quantile.
Similarly, the upper bound is the value of the 97.5 percent quantile of the year with the smallest
97.5% quantile. The y-axis in each of the four panels represents the difference in the predicted
price at the specified input value to the minimum predicted price across the range of input
variables. The predicted price is calculated as the expected price averaged over the input values
of all other explanatory variables in the sample. Refer to Appendix 1 for more details.

44
FIGURE 3: Marginal interactions between accounting amounts and equity price
Panel A: Cash holdings, partitioned by firms with dividends and those without

Panel B: Dividends, partitioned by firms with R&D expense and those without

45
Panel C: R&D expense, partitioned by technology industry membership

This figure presents the marginal relation between accounting amounts and equity price, for
selected interactions of accounting amounts in 2014. The support for the x-axis is set such that
the lower bound is the value of the 2.5 percent quantile of the year with the largest 2.5 percent
quantile. Similarly, the upper bound is the value of the 97.5 percent quantile of the year with the
smallest 97.5% quantile. Similarly, the upper bound is the value of the 97.5 percent quantile of
the subsample with the smallest 97.5 percent quantile. The y-axis represents the predicted price
at the specified accounting amount less the minimum predicted price over the range of
accounting amounts. Refer to Appendix 1 for more details.

46
FIGURE 4: Variable importance for full sample

47
This figure disaggregates the explanatory power of accounting amounts in explaining equity
price into contributions by each amount. The first graph presents variable importance for all
accounting amounts. The second and third graphs present the trend in variable importance for
the five amounts with the largest change in variable importance, as reflected in the table 3
estimates.

48
FIGURE 5: Variable importance for financial firms and technology firms

49
This figure disaggregates the explanatory power of accounting amounts in explaining equity
price into contributions by individual amounts, for financial firms and technology firms. The
first (second) graph presents variable importance for all variables for financial (technology)
firms. The third (fourth) graph presents the trend in variable importance for the three variables
with the largest change in variable importance for financial (technology) firms, as reflected in the
table 4, panel A, estimates.

50
FIGURE 6: Variable importance for loss firms and profit firms

51
This figure disaggregates the explanatory power of accounting amounts in explaining equity
price into contributions by individual amounts, for loss firms and profit firms. The first (second)
graph presents variable importance for all accounting amounts for loss (profit) firms. The third
(fourth) graph presents the trend in variable importance for the three accounting amounts with
the greatest change in variable importance for loss (profit) firms, as reflected in the table 4, panel
A, estimates.
52
FIGURE 7: Goodness of fit for subsamples

This figure graphs the goodness of fit by year for the subsamples of firms. The y-axis represents
the out-of-sample (OOS) R2 for each subsample of firms. The y-axis is the OOS R2 and the x-
axis is fiscal year.

53
FIGURE 8: Variable importance for constant sample of firms

This figure disaggregates the explanatory power of accounting amounts in explaining equity
price into contributions by individual amounts, for a constant sample of firms from 1971-2014.

54
TABLE 1: Descriptive statistics
Panel A: Distributional statistics

Variable Mean Median St. Dev.

P 18.89 13.24 19.58
NI 0.90 0.66 1.97
BVE 10.68 7.48 11.03
CF 1.82 0.99 4.01
CASH 4.10 1.24 13.16
DIV 0.38 0.00 0.64
RD 0.28 0.00 0.66
INTAN 1.79 0.04 4.65
ADV 0.22 0.00 0.73
SPI –0.13 0.00 0.63
OCI –0.14 0.00 0.93
REV 26.14 13.31 36.46
ASSETS 44.21 17.32 84.15
Panel B: Pearson and Spearman correlations

Variable 1 2 3 4 5 6 7 8 9 10 11 12 13
1P 0.61 0.63 0.41 0.50 0.21 0.23 0.33 0.14 –0.01 –0.08 0.38 0.33
2 NI 0.72 0.65 0.45 0.55 0.27 0.08 0.14 0.13 0.36 –0.08 0.44 0.38
3 BVE 0.73 0.70 0.48 0.61 0.38 0.16 0.24 0.17 0.00 –0.06 0.62 0.58
4 CF 0.57 0.60 0.59 0.38 0.23 0.10 0.18 0.11 –0.00 –0.09 0.37 0.28
5 CASH 0.58 0.63 0.65 0.50 0.23 0.06 0.09 0.10 0.02 –0.06 0.36 0.38
6 DIV 0.49 0.37 0.52 0.31 0.29 0.00 0.04 0.01 0.01 –0.03 0.20 0.78
7 RD 0.03 –0.10 –0.09 –0.09 –0.13 0.07 0.08 0.11 –0.09 –0.05 0.16 –0.03
8 INTAN 0.22 0.12 0.17 0.17 0.05 0.14 0.06 0.09 –0.16 –0.07 0.19 0.14
9 ADV 0.03 0.03 0.02 0.02 –0.02 0.08 0.08 0.11 –0.03 –0.05 0.31 0.03
10 SPI 0.04 0.24 0.07 0.04 0.09 0.01 –0.10 –0.17 –0.03 0.06 –0.05 –0.01
11 OCI –0.09 –0.12 –0.10 –0.12 –0.12 –0.03 0.02 –0.04 –0.00 0.00 –0.11 –0.07
12 REV 0.56 0.60 0.71 0.54 0.49 0.36 –0.08 0.24 0.11 0.02 –0.14 0.34
13 ASSETS 0.65 0.61 0.85 0.56 0.61 0.54 –0.22 0.22 0.04 0.03 –0.14 0.74
This table presents descriptive statistics for the 227,289 firm-years for 21,513 firms from 1962-
2014. See Appendix 2 for definition of the variables. Panel A presents distributional statistics
and panel B presents correlations, with Pearson (Spearman) correlations above (below) the main
diagonal.

55
TABLE 2: Changes in value relevance
Panel A: In-sample adjusted R2 and OOS R2 over time

Basic OLS 22-OLS Full OLS CARTs

(1) (2) (3) (4) (5) (6) (7)
Year In-sample OOS In-sample OOS In-sample OOS OOS
1962 63.0 62.2 68.0 63.0 73.2 27.8 62.3
1963 49.2 47.2 55.5 46.8 70.0 <0.0 44.4
1964 54.7 53.9 60.0 55.5 66.6 <0.0 53.2
1965 50.4 49.3 56.1 51.9 63.3 <0.0 55.9
1966 53.6 53.4 60.1 58.2 65.3 <0.0 60.1
1967 46.6 46.5 52.9 51.8 54.6 <0.0 54.1
1968 48.2 47.9 54.1 52.1 59.0 14.9 57.4
1969 41.8 41.6 50.3 49.0 53.3 16.8 50.4
1970 49.9 49.7 56.5 55.8 63.2 49.9 62.6
1971 42.5 42.3 52.8 51.9 59.4 37.6 56.7
1972 42.2 42.1 51.8 51.1 57.1 17.2 57.2
1973 44.5 44.3 53.0 52.4 57.7 26.0 56.8
1974 48.0 47.9 57.6 57.1 63.4 50.3 63.4
1975 57.0 57.0 65.2 64.6 70.6 58.9 69.3
1976 66.9 66.7 75.6 75.2 79.4 70.9 78.6
1977 66.2 66.1 72.9 72.4 78.1 59.8 77.5
1978 61.7 61.5 70.1 69.6 74.5 66.5 72.1
1979 52.9 52.7 63.5 63.1 69.8 <0.0 66.3
1980 54.1 54.0 62.6 62.2 69.1 <0.0 68.9
1981 64.4 64.3 69.5 69.2 76.2 45.4 75.3
1982 59.1 59.0 67.1 66.8 74.2 <0.0 73.6
1983 67.5 67.4 73.2 72.9 78.5 69.5 76.9
1984 71.7 71.6 76.4 76.1 81.3 68.6 80.3
1985 73.0 72.9 77.8 77.4 82.9 69.0 81.4
1986 68.5 68.4 75.3 74.9 81.5 63.7 80.3
1987 68.9 68.9 75.1 74.8 80.3 2.8 78.2
1988 69.1 69.0 76.1 75.8 81.4 <0.0 80.9
1989 66.7 66.6 72.8 72.4 79.3 72.4 78.1
1990 62.6 62.6 70.0 69.6 79.0 10.8 76.9
1991 60.3 60.2 68.8 68.4 76.8 70.2 76.0
1992 62.6 62.6 70.5 70.2 76.6 <0.0 76.0
1993 59.2 59.2 69.1 68.8 74.0 69.0 73.5
1994 58.6 58.5 68.8 68.5 74.8 69.2 74.6
1995 51.9 51.9 62.8 62.6 67.7 63.0 67.1
1996 61.0 61.0 68.8 68.6 73.5 69.3 73.3

56
TABLE 2 (continued): Changes in value relevance
Panel A (continued): In-sample adjusted R2 and OOS R2 over time

Basic OLS 22-OLS Full OLS CARTs

(1) (2) (3) (4) (5) (6) (7)
Year In-sample OOS In-sample OOS In-sample OOS OOS
1997 55.0 55.0 65.4 65.1 71.2 65.7 71.0
1998 34.7 34.6 48.3 48.0 57.4 43.1 57.0
1999 12.3 12.2 31.8 31.6 39.8 24.8 40.1
2000 43.0 43.0 51.3 51.1 58.8 53.0 58.1
2001 50.2 50.1 60.0 59.7 69.1 62.8 69.3
2002 56.3 56.3 64.9 64.7 72.5 66.5 71.6
2003 62.2 62.1 68.8 68.5 74.1 67.3 74.1
2004 63.2 63.1 69.5 69.3 75.8 67.0 75.6
2005 62.8 62.7 68.9 68.6 72.9 67.7 73.5
2006 63.3 63.1 70.2 69.8 73.7 66.3 73.9
2007 57.1 57.0 65.1 64.8 71.3 57.3 70.2
2008 47.8 47.7 59.8 59.4 68.2 59.9 66.9
2009 57.6 57.6 70.2 69.9 75.7 71.4 74.8
2010 57.6 57.6 67.3 67.0 71.0 65.9 70.5
2011 58.0 58.0 67.4 67.1 72.2 63.0 70.1
2012 57.5 57.4 68.1 67.6 72.9 66.9 71.3
2013 54.7 54.5 65.5 65.1 71.4 61.7 69.4
2014 50.7 50.6 68.1 67.7 73.6 65.1 71.0
Mean 55.9 55.7 64.4 63.5 70.3 44.1 68.3

Panel B: Tests of differences in goodness-of-fit

Difference (t-stat) Sig.

(2) – (1) Basic OLS, in sample – OOS –0.2 (4.15) ***
(4) – (3) 22-OLS, in sample – OOS –0.9 (4.19) ***
(6) – (5) Full-OLS, in sample – OOS –26.3 (7.38) ***
(3) – (1) 22-OLS – Basic OLS, in sample 8.5 (21.33) ***
(4) – (2) 22-OLS – Basic OLS, OOS 7.8 (16.44) ***
(5) – (1) Full OLS vs. Basic OLS, in sample 14.4 (28.43) ***
(6) – (2) Full OLS vs. Basic OLS, OOS –11.7 (–3.19) ***
(7) – (2) CARTs – Basic OLS, OOS 12.5 (17.87) ***
(7) – (4) CARTs – 22-OLS, OOS 4.8 (14.63) ***

57
TABLE 2 (continued): Changes in value relevance
Panel C: Regressions of value relevance over time

Coef. (t-stat)
(1) Basic OLS 0.057 (0.60)
(2) 22-OLS 0.189** (2.34)
(3) CARTs 0.254*** (3.18)
(4) CARTs – Basic OLS 0.198*** (5.32)
(5) CARTs – 22-OLS 0.065*** (3.35)
(6) 22-OLS – Basic OLS 0.132*** (5.26)
Panel A presents explanatory power of Equations (1) to (4) in percentages. See Appendix 2 for
variable definitions. Basic OLS is:
𝑃𝑖 = 𝛽0 + 𝛽1 𝑁𝐼𝑖 + 𝛽2 𝐵𝑉𝐸𝑖 + 𝜀𝑖
22-OLS is a regression of price on twelve accounting amounts plus Fama-French 10 industry
indicators:
𝑃𝑖 = 𝛽0 + 𝛽1 𝑁𝐼𝑖 + 𝛽2 𝐵𝑉𝐸𝑖 + 𝛽3 𝐶𝐹𝑖 + 𝛽4 𝐶𝐴𝑆𝐻𝑖 + 𝛽5 𝐷𝐼𝑉𝑖 + 𝛽6 𝑅𝐷𝑖 + 𝛽7 𝐼𝑁𝑇𝐴𝑁𝑖 + 𝛽8 𝐴𝐷𝑉𝑖
10

+ 𝛽9 𝑆𝑃𝐼𝑖 + 𝛽10 𝑂𝐶𝐼𝑖 + 𝛽11 𝑅𝐸𝑉𝑖 + 𝛽12 𝐴𝑆𝑆𝐸𝑇𝑆𝑖 + ∑ 𝛽13,𝑗 𝐼𝑁𝐷10𝑗𝑖 + 𝜀𝑖

𝑗=1

Full OLS is a regression of price on twelve accounting amounts, with interactions with the Fama-
French 10 industries and loss firms
10 10 12

𝑃𝑖 = 𝛽0 + 𝛽1 𝐿𝑂𝑆𝑆𝑖 + ∑ 𝛽2𝑗 𝐼𝑁𝐷10𝑖 + ∑ ∑ 𝛽3𝑗𝑘 𝐼𝑁𝐷10𝑗𝑖 ×𝑉𝐴𝑅𝑘𝑖

𝑗=1 𝑗=1 𝑘=1

10 12

+ ∑ ∑ 𝛽3𝑗𝑘 𝐼𝑁𝐷10𝑗𝑖 ×𝑉𝐴𝑅𝑘𝑖 ×𝐿𝑂𝑆𝑆𝑖 + 𝜀𝑖

𝑗=1 𝑘=1

𝑉𝐴𝑅𝑘 = {𝑁𝐼, 𝐵𝑉𝐸, 𝐶𝐹, 𝐷𝐼𝑉, 𝑂𝐶𝐼, 𝑅𝐷, 𝐶𝐴𝑆𝐻, 𝐼𝑁𝑇𝐴𝑁, 𝐴𝐷𝑉, 𝑆𝑃𝐼, 𝑅𝐸𝑉, 𝐴𝑆𝑆𝐸𝑇𝑆}
The CART equation estimates a CART prediction function on the same accounting amounts in
Full OLS, plus indicator variables for each of the Fama-French 10 industries (Appendix 1). The
adjusted R2 is the in sample adjusted R2 calculated from the OLS equations. OOS R2 is the
proportion of variation explained in an out-of-sample test data set, based on ten-fold cross-
validation for OLS methods and out-of-bag error estimates for CARTs.

58
TABLE 2 (continued): Changes in value relevance
Panel B presents differences in the explanatory power of the equations in panel A.
Panel C presents estimates of 𝛽1 in Equation (5), the explanatory power over time:
𝑂𝑂𝑆𝑅2𝑡 = 𝛽0 + 𝛽1 𝑌𝐸𝐴𝑅𝑡 + 𝜀𝑡
𝑂𝑂𝑆𝑅2 is (i) the out-of-sample (OOS) R2 in percentages and 𝑌𝐸𝐴𝑅 is year. Coefficient
estimates of 𝛽1 and t-statistics are presented. *, **, and *** indicate difference from zero,
significant at the 10, 5, and 1 percent levels, using a two-tailed t-test.

59
TABLE 3: Changes in value relevance of individual accounting amounts
Panel A: Changes in variable importance

Variable Coef. (t-stat)

NI – 0.730*** (–11.21)
BVE 0.402*** (5.98)
CF 0.249*** (9.91)
CASH 0.099*** (3.91)
DIV – 0.120*** (–4.93)
RD 0.058*** (3.02)
INTAN 0.043*** (8.08)
ADV 0.001 (0.16)
SPI 0.035*** (5.41)
OCI 0.000 (0.05)
REV 0.002 (0.12)
ASSETS – 0.044 (–1.50)
IND 0.005 (0.08)
This panel presents estimates of the variable importance of accounting amounts over time:
𝑉𝐴𝑅𝐼𝑀𝑃𝑡 = 𝛽0 + 𝛽1 𝑌𝐸𝐴𝑅𝑡 + 𝜀𝑡
𝑉𝐴𝑅𝐼𝑀𝑃𝑡 is the relative variable importance for a given accounting amount in year 𝑡, which is
the share (in percent) of the total increase in mean squared error from randomly assigning the
accounting amount, and 𝑌𝐸𝐴𝑅𝑡 is fiscal year 𝑡. Table values represent the estimates of 𝛽1. *,
**, and *** indicate difference from zero, significant at the 10, 5, and 1 levels, using a two-tailed
t-test.

60
TABLE 3 (continued): Changes in value relevance of individual accounting amounts
Panel B: Number of important accounting amounts over time

Threshold Coef. (t-stat)

(1) 1 percent 0.092*** (9.50)
(2) 2 percent 0.076*** (7.76)
(3) 3 percent 0.041*** (3.51)
(4) 5 percent 0.021** (2.29)
(5) 10 percent 0.023*** (3.18)
This panel presents estimates of changes in the number of important accounting amounts over
time:
𝐼𝑀𝑃𝑡 = 𝛽0 + 𝛽1 𝑌𝐸𝐴𝑅𝑡 + 𝜀𝑡
𝐼𝑀𝑃𝑡 is the number of important accounting amounts in year 𝑡, which is the number of
accounting amounts with higher than 1, 2, 3, 5, and 10 percent share in the total increase in mean
squared error from randomly assigning variables, and 𝑌𝐸𝐴𝑅𝑡 is fiscal year 𝑡. Table values
represent the estimates of 𝛽1. *, **, and *** indicate difference from zero, significant at the 10,
5, and 1 percent levels, using a two-tailed t-test.

61
TABLE 4: Intertemporal trends in value relevance for subsamples
Panel A: Average Ranks

Full Fin Tech Tech – Fin –

Variable (1) Rank (2) Rank (3) Rank Fin – Full Full Tech
NI 1.09 1 1.11 1 1.32 1 0.02 0.22* – 0.20
BVE 2.55 2 2.30 2 3.61 2 – 0.25 1.07*** – 1.32***
ASSETS 3.26 3 4.20 4 4.73 3 0.94*** 1.46*** – 0.52*
REV 5.51 4 4.73 5 5.32 4 – 0.78*** – 0.19 – 0.59*
DIV 5.57 5 3.48 3 8.00 9 – 2.09*** 2.43*** – 4.52***
RD 6.91 6 10.80 12 6.11 7 3.89*** – 0.79* 4.68***
CF 7.09 8 7.66 7 5.52 6 0.56 – 1.57*** 2.14***
CASH 7.32 9 6.14 6 5.48 5 – 1.18*** – 1.84*** 0.66
INTAN 10.98 10 9.45 9 9.95 10 – 1.53*** – 1.03*** – 0.50
SPI 11.00 11 9.84 10 10.64 11 – 1.16*** – 0.36 – 0.80**
ADV 11.36 12 9.95 11 11.50 13 – 1.40*** 0.14 – 1.55***
OCI 11.36 12 8.34 8 11.36 12 – 3.02*** 0.01 – 3.02***
IND 7.00 7 13.00 13 7.45 8 6.00*** 0.45 5.55***

Loss Profit Loss – Profit – Loss –

Variable (4) Rank (5) Rank Full Full Profit
NI 9.27 10 1.00 1 8.18*** – 0.09* 8.27***
BVE 1.50 1 2.55 2 – 1.05*** – 0.00 – 1.05***
ASSETS 2.75 2 3.36 3 – 0.51** 0.10 – 0.61**
REV 5.50 4 5.57 4 – 0.01 0.06 0.07
DIV 7.30 7 5.73 5 1.73*** 0.16 – 1.57***
RD 5.55 5 6.09 6 – 1.36*** – 0.81** – 0.55*
CF 7.30 7 7.09 7 0.20 – 0.00 0.20
CASH 4.45 3 8.27 9 – 2.87*** 0.95*** – 3.82***
INTAN 9.07 9 10.86 10 – 1.91*** – 0.12 – 1.80***
SPI 9.80 11 11.09 12 – 1.20*** 0.09 – 1.30***
ADV 11.02 12 10.89 11 – 0.34 – 0.47 – 0.14
OCI 11.64 13 11.18 13 0.28 – 0.18 0.45
IND 5.86 6 7.32 8 – 1.14 0.32 – 1.45**

62
TABLE 4 (continued): Intertemporal trends in value relevance for subsamples
Panel B: Variable importance over time

Fin Tech Tech – Fin –

Variable (1) (t-stat) (2) (t-stat) Fin – Full Full Tech
NI – 0.602*** (–4.00) – 1.369*** (–8.89) 0.128 – 0.639*** 0.767***
BVE 0.418*** (2.86) 0.180** (2.57) 0.016 – 0.222** 0.238
CF 0.084*** (6.28) 0.683*** (6.99) – 0.165*** 0.434*** – 0.599***
CASH 0.016 (0.64) 0.283*** (3.91) – 0.083** 0.184*** – 0.267***
DIV – 0.075 (–1.36) – 0.094** (–2.59) 0.045 0.026 0.019
RD 0.007*** (5.06) – 0.030 (–0.71) – 0.051** – 0.088** 0.037
INTAN 0.034*** (7.21) 0.090*** (5.62) – 0.009 0.047*** – 0.056***
ADV 0.003 (0.91) – 0.006 (–1.49) 0.002 – 0.007 0.009*
SPI 0.025** (2.04) 0.032*** (2.77) – 0.010 – 0.003 – 0.007
OCI – 0.031 (–1.61) – 0.004 (–0.77) – 0.031* – 0.004 – 0.027
REV 0.082*** (3.48) 0.012 (0.29) 0.080** 0.010 0.070
ASSETS 0.040 (1.26) 0.149*** (2.88) 0.084* 0.193*** – 0.109*
IND 0.000 N/A 0.074** (2.57) – 0.005 0.069 – 0.074**

Loss Profit Loss – Profit – Loss –

Variable (3) (t-stat) (4) (t-stat) Full Full Profit
NI 0.019 (1.45) – 0.496*** (–5.47) 0.749*** 0.234** 0.515***
BVE – 0.576*** (–2.92) 0.260*** (3.31) – 0.978*** – 0.142 – 0.836**
CF 0.224*** (4.60) 0.291*** (8.99) – 0.025 0.042 – 0.067
CASH 0.354*** (5.60) 0.051** (2.17) 0.255*** – 0.048 0.303***
DIV – 0.124*** (–4.01) – 0.134*** (–5.71) – 0.004 – 0.014 0.010
RD 0.117* (1.82) 0.032 (1.07) 0.059 – 0.026 0.085
INTAN 0.084*** (3.81) 0.069*** (7.15) 0.041** 0.026** 0.015
ADV – 0.006 (–0.67) – 0.010 (–0.92) – 0.007 – 0.011 0.004
SPI 0.012 (0.44) 0.043*** (3.84) – 0.023 0.008 – 0.031
OCI – 0.019 (–1.50) 0.002 (0.44) – 0.019* 0.002 – 0.021
REV – 0.037 (–0.50) – 0.023 (–0.92) – 0.039 – 0.025 – 0.014
ASSETS – 0.093 (–0.96) – 0.063* (–1.74) – 0.049 – 0.019 – 0.030
IND 0.047 (0.39) – 0.022 (–0.56) 0.042 – 0.027 0.069

This table presents variable importance measures by industry. Panel A presents the average rank
of each accounting amount in a ranking of variables in terms of variable importance (Appendix
2) over the years in the sample. Panel B presents the findings from estimating
𝑉𝐴𝑅𝐼𝑀𝑃𝑡 = 𝛽0 + 𝛽1 𝑌𝐸𝐴𝑅𝑡 + 𝜀𝑡

63
TABLE 4 (continued): Intertemporal trends in value relevance for subsamples
In panel B, 𝑉𝐴𝑅𝐼𝑀𝑃 is the share of the total increase in out-of-sample mean squared error from
permuting variables (Appendix 2). Values represent the estimates of 𝛽1. Difference p-value
refers to the difference in the average ranks (coefficients) between subsamples and the full
sample, or between two subsamples, in panel A (B), using a two-tailed t-test. *, **, and ***
indicate difference from zero, significant at the 10, 5, and 1 levels, using a two-tailed t-test.

64
TABLE 5: Value relevance for constant sample
Panel A: Average Ranks

Constant Const –
Variable (1) Rank Full
NI 1.05 1 – 0.05
BVE 3.98 2 1.43***
ASSETS 5.25 4 1.99***
REV 8.07 8 2.56***
DIV 4.59 3 – 0.98**
RD 5.98 5 – 0.93**
CF 6.14 6 – 0.96
CASH 10.52 13 3.20***
INTAN 9.18 9 – 1.80***
SPI 10.48 12 – 0.52
ADV 9.32 10 – 2.04***
OCI 9.64 11 – 1.72***
IND 6.82 7 – 0.18
Panel B: Changes in variable importance

Const Const –
Variable (1) (t-stat) Full
NI 0.106 (0.72) 0.836***
BVE – 0.076 (–0.85) – 0.478***
CF 0.320*** (5.31) 0.071
CASH – 0.031** (–2.03) – 0.130***
DIV 0.049 (1.63) 0.169***
RD – 0.071 (–0.90) – 0.129*
INTAN 0.052*** (3.81) 0.009
ADV – 0.032 (–1.55) – 0.033*
SPI 0.028** (2.12) – 0.007
OCI – 0.057*** (–4.12) – 0.057***
REV – 0.080*** (–4.55) – 0.082***
ASSETS – 0.140*** (–4.99) – 0.096**
IND 0.069 (–1.09) 0.064
This table presents variable importance measures for a constant sample of firms from 1971-2014.
Panel A presents the average rank of each accounting amount in a ranking of variables in terms
of variable importance (Appendix 2) over the years in the sample. Panel B presents the findings
from estimating
𝑉𝐴𝑅𝐼𝑀𝑃𝑡 = 𝛽0 + 𝛽1 𝑌𝐸𝐴𝑅𝑡 + 𝜀𝑡 .

65
TABLE 5: Value relevance for constant sample (continued)
In panel B, 𝑉𝐴𝑅𝐼𝑀𝑃 is the share of the total increase in out-of-sample mean squared error from
permuting variables (Appendix 2). Values represent the estimates of 𝛽1. Difference p-value
refers to the difference in the average ranks (coefficients) between subsamples and the full
sample, or between two subsamples, in panel A (B), using a two-tailed t-test. *, **, and ***
indicate difference from zero, significant at the 10, 5, and 1 percent levels, using a two-tailed t-
test.

66