Journal of Economics and Finance (2020) 44:434–457

https://doi.org/10.1007/s12197-019-09491-7

Firm size proxies and the value relevance of predictive

stock return models

Gulraze Wakil 1

Published online: 31 August 2019

# Academy of Economics and Finance 2019

Abstract
This paper investigates differences in value relevance of predictive stock return models
depending on which firm size proxy (or proxies) is used, these being market value (MV),
total book assets (TBA) and market value of total book assets (MVTA). Over the 27 year
period of 1989–2015, MV provides higher value relevance in predicting future returns,
while TBA provides higher value relevance when limited to large firms. Moreover,
results reveal incremental explanatory power of approximately 27% when TBA are
added to a one-year-ahead returns model already containing MV. The increase is 60%
when examining only the last 10 years of the sample period. The findings of this study
will help future accounting and finance research that uses predictive return models and
potentially allow investors to make better resource allocation decisions leading to higher
risk adjusted returns. In addition, the findings related to TBA will add to the debate on
whether standard setters should place more emphasis on the valuation of assets and
liabilities relative to earnings.

Keywords Firm size . Value relevance . Accounting assets

JEL classification G12 . G17 . M410

1 Introduction

Investors, corporate managers, and researchers desire a more accurate model to esti-
mate stock returns in order to make better portfolio allocation decisions and to
determine which factors are related to future stock returns. Numerous papers have
examined models and their explanatory variables for predicting stock returns, including
Ball and Brown (1968), Fama and French (1995), Brown and Sivakumar (2003),

* Gulraze Wakil
gwakil@ryerson.ca

1
Ted Rogers School of Management, School of Accounting and Finance, Ryerson University, 350
Victoria St., Toronto, ON M5B 2K3, Canada
Journal of Economics and Finance (2020) 44:434–457 435

Campbell and Thompson (2008) and Penman (2011), among others. Brown and
Sivakumar compare operating earnings to “bottom-line” GAAP net income
and find operating earnings provide greater value relevance in predicting future
stock returns. However, no prior study has shown how the use of different firm
sizes proxies, including non-market determined proxies, can affect the value
relevance (interchangeably referred to as stock return predictability in this
paper) of these models.
Hence, this study fills this gap by investigating the relative and incremental value
relevance of three firm size proxies in predicting stock returns. Most predictive stock
return models only utilize a firm’s market capitalization (MV) as the firm size proxy, so
it would be insightful to compare other firm size proxies with MV for potentially
improving stock return prediction.1 Increased value relevance from reliable and easily
obtained information will reduce cost of capital and increase market efficiency (e.g.,
Lambert et al. 2007; Callen et al. 2013; Givoly et al. 2017). Moreover, Campbell and
Thompson (2008) analytically show that better stock prediction leads to higher portfo-
lio returns for the mean-variance investor.
Specifically, I compare the value relevance of market value (MV), total book assets
(TBA) and an estimate of the market value of total book assets (MVTA) as proxies for
firm size in asset pricing/returns models. TBA is chosen because it is a non-market
measure based on accounting standards and management judgement rather than on
independent external investors as is the case for MV. Therefore TBA comprises infor-
mation that is not included in MV.2 Moreover, TBA can be used in contemporaneous
models that involve stock returns. Conversely, MV cannot be used in contemporaneous
return models because, for the same time period, the changes in MV are almost identical
to stock returns.
Nevertheless, a major criticism of TBA is that it is based on historical values and not
adjusted for current value. Therefore, MVTA is also examined. This size proxy is
mixture of market and accounting values and is an approximation of the current value
of TBA. MVTA is more in line with International Accounting Standards Board’s
conceptual framework, which is supportive of current value accounting (IFRS
Foundation 2010).
From 1989 to 2015, firm-level Fama and MacBeth (1973) regression results show
that predictive stock return models using MV have higher value relevance than using
TBA or MVTA as the size proxy. The respective adjusted R2, which is a measure of how
well the independent variables explain variation in firm-level future returns, is 4.10%,
3.90%, and 3.80% when using MV, TBA, and MVTA, respectively. However, TBA
provide higher value relevance for firms in the upper MV quartile. Further testing is

1
Bujaki and Richardson (1997) present firm size proxies used in five major accounting journals. For expected
returns, they report all articles to have used MV. From examination of more recent articles in major accounting
journals, I find that this is largely still the case. In addition, recent empirical articles in the Journal of Finance
almost always use MV as the size proxy.
2
Although firm size proxies are commonly used as control variables, they also represent general character-
istics of the firm. TBA ae likely going to be negatively related to expected returns due to their association with
lower bankruptcy risk and better earnings quality, and these two firm characteristics have been shown to be
negatively related to expected returns (e.g., Griffin and Lemmon 2002; Lambert et al. 2007; Chava and
Purnanandam 2010). MVTA have been used as the numerator in Tobin’s Q as a firm valuation proxy (e.g.,
Moeller et al. 2004; Thomsen et al. 2006).
436 Journal of Economics and Finance (2020) 44:434–457

performed to determine the extent to which TBA provide any incremental value
relevance to a predictive future returns model that already contains MV. When TBA is
added, the explanatory power of the model increases from 4.10% to 5.20% (an increase
of 26.8%). Although the absolute magnitude of this increase in R2 is only 1.1%, using
the method derived in Campbell and Thompson (2008, p. 1524) this represents an
added 1 % in portfolio returns for the mean-variance investor. These results are robust
to using different sample periods and extensive control variables, including debt-to-
total assets, earnings yield, accruals, and asset growth.3
This study contributes to the evaluation of firm size proxies in asset pricing
models in three ways. First, the use of MV provides the highest relative
explanatory power at the firm-level using all firms, but TBA provides the
highest value relevance when using only the highest quartile MV firms.
Therefore, in applications that primarily examine large MV firms, TBA is
potentially the better proxy for firm size. Examination of relatively large MV
firms is common in corporate governance, audit and employee compensation
studies (e.g., Bell et al. 2001; Gompers et al. 2003; Cheng 2004; Erkens and
Bonner 2013). MV is often the size proxy used, so the findings of these large
firm studies might be strengthened if TBA is used as the firm size proxy. In
addition, institutional investors are often restricted to investing in larger firms (O'Brien
and Bhushan 1990; Collins et al. 2003). They may be able to justify investing in small
MV firms if these same firms have large TBA values.
Second, the inclusion of two different proxies for size in a predictive returns model,
specifically MV and TBA, significantly increases the explanatory power of the model
(adjusted R2 increases by 26.8%). This increased return predictability and better asset
pricing model will be useful for accounting and finance scholars conducting studies
related to capital markets and will provide investors with the potential to make better
resource allocation decisions leading to greater risk adjusted returns (Campbell and
Thompson 2008). Finally, the findings of this paper on TBA add to the debate on the
merits of standard setters’ (both FASB and IASB) shift from an income to a balance
sheet approach that emphasizes valuation of assets and liabilities (FASB 2006;
Demerjian 2011).4 This paper clearly shows that TBA are related to stock returns beyond
that of MV.
The remainder of this paper is organized as follows: Section 2 is a literature review
of asset pricing models and proxies for firm size, section 3 develops the hypotheses and
section 4 describes the sample and univariate correlations. Section 5 develops the
research methods for value relevance testing and presents the findings and their
interpretations, section 6 presents additional robustness testing and limitations, and
section 7 provides the conclusion of this study.

3
The control variables for the main predictive returns model used in this paper are dividend yield, CAPM beta
and the book-to-market ratio. By adding individually or jointly the natural log of debt-to-total assets, return on
assets or sales, earnings yield, current returns, accruals, and asset growth, the incremental value relevance and
statistical significance of TBA is robust in all cases. Also, TBA provide the highest incremental value relevance
to a model that already contains MV compared to these additional variables.
4
Financial reporting should provide information about an entity’s resources (assets) and the claims to those
resources. Information about the effects of transactions and other events are indicated as “also” essential
(Preliminary views in Financial Accounting Series NO. 1260–001, 2006). However, recent papers by Watts
and Zuo (2016) and Dichev (2017) still purport the income statement as being primary.
Journal of Economics and Finance (2020) 44:434–457 437

2 Review of related literature

2.1 The “size effect”

Most empirical studies use firm size, proxied by market value (MV) of a firm’s common
stock, as an independent variable in stock and even non-stock return models. Banz
(1981) and Fama and French (1992) are prominent early papers that empirically
document the MV “size effect” on stock returns not explained by the Capital Asset
Pricing Model.5 However, although useful in these models, no theoretical justification
is given for the “size effect.” Banz conjectures that this effect may be due to smaller
firms having greater information risk, but notes that MV could be capturing the effect of
some other variable that is correlated with market value. Penman (2011, p. 23) states
that, “Indeed, adding variables like B/P [book-to-price ratio], size and momentum as
controls for risk is mere conjecture, for these variables have been included in nominated
asset pricing merely by observing correlations – data dredging – not from analytical
development.” However, Fama and French (1995) document the negative relationship
of MV to portfolio returns also being related to fundamental factors (earnings and sales)
in stock returns, which supports rational pricing. This is particularly the case with small
firms (below median MV) after controlling for the book-to-market ratio. A different
explanation is given in Berk (1995, 1997). MV is less related to the operating charac-
teristics of the firm than to the riskiness of expected cash flows. Berk (1995) theoret-
ically derives that MV is negatively related to expected stock returns and that this
relation is not an anomalous result. Rather it is endogenous because higher expected
stock returns or discount rate leads to lower MV in equilibrium. Subsequent studies
have also explained this “size effect.” For example, the fundamental reasons explana-
tion is supported by Perez-Quiros and Timmerman (2000) who find small MV firms’
stock returns are more sensitive to fluctuations in economic cycles than large MV firms
due to higher credit risk of small firms in recessions. A detailed review of the various
explanations for the size (MV) effect is found in van Dijk (2011), which classifies the
reasons as risk, liquidity, behavioral and statistical methods.

2.2 Book value and market value of Total book assets

Another proxy for firm size is accounting assets, referred to as total book assets (TBA)
in this paper, from a company’s balance sheet. TBA is often used in models that do not
involve or examine stock returns. For example, TBA is used as the firm-size proxy in
Defond et al. (2002) and Goh et al. (2013) to examine firms with going concern audit
opinions. Chen and Chang (2010) also show that TBA are positively related to patent
citations for pharmaceutical firms. TBA are also sometimes used as a size control in
earnings quality studies (e.g., Ball and Shivakumar 2005; Francis et al. 2005; Ecker
et al. 2006) where TBA are shown to be associated with better earnings quality. One of
the few studies evaluating TBA and stock returns is a working paper by Berk (1996),
5
Banz (1981) uses a generalized asset pricing model, which includes a variable for the market value of a firm
less the average value of NYSE stocks, all divided by the average value of NYSE stocks, to determine a
relationship between market value and returns of common stocks. Even after controlling for the market beta,
size was negatively related to returns. Banz notes that the size effect is not linear and is more concentrated in
small firms. The findings of the current study reveal that this is still the case.
438 Journal of Economics and Finance (2020) 44:434–457

which explores if TBA has any statistically significant relationship with future stock
returns. However, the evidence provided is inconclusive and the general thrust of the
working paper is that TBA and other non-market firm size measures do not explain
future returns.6
A major shortcoming of the size proxy, TBA, is that book values are primarily based
on original cost and not adjusted for changes in value, which makes TBA less relevant.7
One reason for not adjusting TBA to current values is due to conservatism; an
accounting principle that biases asset values downward. Nevertheless, conservatism
has benefits and continues to be used in the US for efficient debt and equity contracting
(Lara et al. 2014; Kang et al. 2017). Therefore, it is arguable whether TBA adjusted for
current values is beneficial. To address the criticism of TBA not being adjusted for
current value, I use the accounting identity TBA = TL + TBE, where TL represents total
book liabilities and TBE represents total book equity of the firm, to obtain an approx-
imation of the current market value of TBA. Working with the right-hand side of the
accounting identity, the market value of TBE is the market value (MV) and total
liabilities (TL) are close to their current value because most obligations are payable at
their reported accounting amount. Therefore, working with the right-hand side of the
accounting identity, the market value of total book assets (MVTA) is approximated by
TL + MV. MVTA is the third firm size proxy analyzed in this paper and is analogous to
proxies used for the replacement cost of total book assets in the numerator of Tobin’s Q
(e.g., Moeller et al. 2004; Thomsen et al. 2006).

2.3 Value relevance research

Value relevance in both the accounting and finance literature examines the association
between stock returns (or stock price) and explanatory variables and can generally be
divided between relative and incremental value relevance. The former involves the
explanatory power comparison of two variables (pieces of information) or comparison
of two time periods, while the latter attempts to show whether an increase in explan-
atory power occurs when adding another variable (additional information) to the model.
This paper examines both forms of value relevance.
Early accounting studies evaluated earnings quality by how well earnings explained
contemporaneous stock returns or prices (e.g., Easton et al. 1992; Dechow 1994; Bernard
1995). Easton et al. (1992) find little value relevance of the above relationship over one- or
two-years, but find a substantial increase in R2 and the statistical significance of the
coefficients over longer periods of five to 10 years. Another example is Brown and
Sivakumar (2003), who compare the value relevance of operating income reported by
managers and analysts to 10-k filings operating income in equity valuation models. They
find that relative value relevance is higher for operating income reported by managers and

6
He obtains a coefficient of −0.099 on TBA with a p value of 0.067 when TBA is used as the sole size proxy in
a univariate predictive returns model. However, in the same working paper, regressing returns on the residuals
of MV that are orthogonal to TBA provided a stronger relationship than just regressing returns on MV, thus
indicating that TBA do not provide any information on future returns. The sample firms used in the Berk
(1996) working paper are restricted to firms on the NYSE. The current paper uses firms on the NYSE, AMEX,
and NASDAQ stock exchanges.
7
Although, in 2001, FASB required goodwill to be checked for impairments annually to increase the accuracy
of the balance sheet (Cheng et al. 2017).
Journal of Economics and Finance (2020) 44:434–457 439

analysts. More recently, Givoly et al. (2017) explore the differences in value relevance for
debt holders compared to equity holders using the adjusted R2 of stock returns’
relationship to credit and income variables, among others. They find value relevance
has increased for debt holders but decreased for equity holders.
The above studies examine relative value relevance, which is more common than
incremental value relevance in the literature. Nevertheless, Biddle et al. (1995) report
higher incremental value relevance of net income over cash flows or net sales and
Biddle et al. (1997) find that EVA (economic value added) does not add much
incremental value relevance over earnings in explaining stock returns. Still, relative or
incremental value relevance of TBA in explaining future returns has not been examined.

3 Hypothesis development

The literature on the relationship between market value (MV) and future returns has
consistently shown it to be negative and statistically significant. On the other hand, total
book assets (TBA) are almost never used in predictive returns models.8 However, I
expect that TBA will have a relationship with future stock returns because as presented
in the literature review, going-concern issues and lower earnings quality are negatively
related to TBA. The former indicates lower bankruptcy risk and the latter indicates
lower information risk with higher levels of TBA. Both lower bankruptcy risk and better
earnings quality have been shown to be negatively related to expected returns (e.g.,
Griffin and Lemmon 2002; Chava and Purnanandam 2010; Lambert et al. 2007).
Lambert et al. theoretically show that better accounting information can reduce the cost
of capital and information risk reduction is undiversifiable. Callen et al. (2013) even find
that future realized returns are negatively related to better earnings quality. These studies
indirectly support the proposition that the firm-size proxy, TBA, provides some value
relevance in predictive returns models, though not necessarily greater than MV.
Still, to my knowledge, no study compares changes in value relevance of the whole
predictive returns model from the following three size proxies: market value (MV), total
book assets (TBA) and market value of total book assets (MVTA). Therefore, I do not
make any initial predictions about which size measure will provide higher relative
value relevance. This leads to the first hypothesis presented below in the null form:9

HYPOTHESIS 1: There is no difference in the relative value relevance of MV,

TBA and MVTA in explaining future stock returns when used individually in a
predictive returns model as the sole size proxy.

The second hypothesis of this paper relates to how TBA and MVTA affect the explan-
atory power of a firm-level future returns model that already contains MV (incremental
value relevance). For TBA to increase the explanatory power in a model that already

8
Two exceptions are Berk (1996) and Badertscher et al. (2011). As presented in sub-section 2 (ii) of the
literature review, Berk (1996) gets inconclusive evidence on the statistical significance of TBA. Badertscher
et al. (2011) use TBA in a model that examines cumulative market adjusted returns’ relation to accounting
restatements 60 days after the announcement, but obtain statistically insignificant results for size proxy TBA.
However, neither papers assess the value relevance of using TBA in a one-year-ahead predictive returns model.
9
The arguments for TBA used in hypotheses 1 and 2 are the same for MVTA.
440 Journal of Economics and Finance (2020) 44:434–457

contains MV, TBA would need to add new information for explaining returns that are
orthogonal to MV. I predict that new information is present in TBA because they are
related more to the tangible and physical attributes of size, while MV is closer to the
(levered) value definition of size. Berk (1995) analytically shows that MV is related to
the discount rate of the stock because of its endogenous relationship to future returns,
not because of some fundamental factor. In contrast, TBA is a fundamental factor that is
subject to accounting standards and management judgement. Again, this supports new
information in TBA for predicting future returns that is not in MV. Therefore, the second
hypothesis is presented in alternate form:

HYPOTHESIS 2: TBA (and MVTA) will increase the explanatory power of a

predictive returns model that already contains MV.

Finally, although not a formal hypothesis, this paper also tests whether the growth in
assets subsumes or reduces the effect of the level of TBA with future stock returns.
Cooper et al. (2008) and Lam and Wei (2011) both show growth in assets to be
negatively related to future returns. Therefore it is possible that asset growth subsumes
or reduces the effect of the level of TBA for return predictability. This is examined in the
Robustness testing and limitations section of this paper (section 6).

4 Sample and descriptive statistics

4.1 Data sources and sample selection

All available US firm-level financial data are obtained from Standard & Poor’s
Compustat Annual Industrial and Research files. Stock return and market valuation
data are obtained from the Center for Research on Security Prices (CRSP) monthly
stock return database. In order to be consistent with prior studies, I only include non-
financial firms and those traded on the New York, American and NASDAQ stock
exchanges. The sample spans years 1989–2015, resulting in 74,989 firm-year observa-
tions for testing (Table 1). Firms are not restricted to ones that have a December fiscal
year-end month and all independent variables, excluding MV, are at the fiscal year-end
date of each firm. MV date is the start of the annual return cumulation period, which
starts in the fourth or seventh month after a firm’s fiscal year-end.
Table 1 (Panel A) presents descriptive statistics for all of the variables used in Eq.
(1), the main model used for value relevance testing in section 5 below. The one-year-
ahead buy-and-hold returns (RET) have a mean (median) value of 15.4% (5.7%). For
comparison, the CRSP equal (value)-weighted index had an average annual return of
14.4% (11.5%) over the same period. The slight positive return bias in the sample
corresponds to the mean CAPM beta (BETA) of the current sample of 1.207 and it
appears that the cross-section has a large group of firms with considerably high returns.
Next, the mean values of the two size proxy variables market value (MV) and total book
assets (TBA) are approximately equal at around $2.2 billion. Since TBA are not net of
liabilities, the market or current value of accounting assets is understated by TBA. The
market value of total book assets (MVTA), which has a mean value of approx-
imately $3.6 billion, is a better representation for the current value of TBA.
Table 1 This table reports the average cross-sectional descriptive statistics (Panel A) and correlation coefficients (Panel B) for the variables listed using all US firms traded on the
NYSE, AMEX, and NASDAQ exchanges, excluding firms in the financial industry.

Panel A Descriptive statistics

Variable Mean Std. Dev. Median 25th percentile 75th percentile
FMO 9.881 3.391 12.000 9.000 12.000
RET 0.154 0.623 0.057 −0.225 0.370
RF 0.031 0.024 0.035 0.009 0.051
DIVY 0.010 0.020 0.000 0.000 0.013
BETA 1.207 0.990 1.079 0.602 1.648
BTM 0.618 0.542 0.482 0.282 0.770
MV 2,160 5,573 300 75 1,292
TBA 2,379 6,759 278 71 1,288
MVTA 3,593 9,288 473 120 2,102
Journal of Economics and Finance (2020) 44:434–457

Panel B Pair-wise Correlations (Pearson above and Spearman below diagonal)

Variable RET DIVY BETA BTM MV TBA MVTA CFO TBAgr
RET 0.009 −0.004 0.121 −0.037 −0.017 −0.027 −0.016 −0.043
DIVY 0.079 −0.190 0.086 0.125 0.203 0.175 0.175 −0.038
BETA −0.052 −0.259 −0.064 −0.055 −0.067 −0.065 −0.069 0.010
BTM 0.110 0.104 −0.094 −0.144 −0.039 −0.109 −0.068 −0.049
MV −0.003 0.352 0.027 −0.312 0.820 0.954 0.848 0.002
TBA 0.065 0.438 −0.030 0.016 0.869 0.945 0.916 −0.004
MVTA 0.023 0.390 0.006 −0.223 0.965 0.949 0.913 −0.003
CFO 0.105 0.457 −0.119 −0.030 0.732 0.794 0.771 −0.012
TBAgr −0.088 −0.060 −0.007 −0.223 0.179 0.063 0.134 0.080

For inclusion in the base sample, firms must also have available data for the variables in the main regression model- Eq. (1), resulting in 74,989 observations over the sample period 1989–2015. FMO is the
average fiscal year-end-month, RET is the annualized cum-dividend one-year-ahead raw return obtained from the CRSP monhtly stock file and RF is the annualized risk free rate using one-month Treasury bill
rates obtained from the Fama and French website (both in decimal form). DIVY is the dividend yield [Compustat item DVYDF in decimal form]. BETA is the CAPM beta, calculated for each firm-year using the
preceding 48 month returns and CRSP value weighted market returns. BTM is the book-to-market ratio [inverse of Compustat item MKBKF]. MV is market value of the firm obtained from CRSP and TBA is total
book assets [Compustat item AT], both in millions $. MVTA is an estimate for the market value of TBA: MV + book value of total liabilities in millions $ [Compustat item TL]. CFO is cash flows from operations
[Computstat item #308] and TBAgr is % change in TBA. All correlations are significant at below the 1% level except the ones in bold.
All continuous variables are winsorized at 1% and 99% of their respective distributions.
441
442 Journal of Economics and Finance (2020) 44:434–457

4.2 Univariate analysis of the association among variables

Table 1 (Panel B) presents the Pearson and Spearman correlation coefficients (ρ) among
one-year-ahead returns (RET), dividend yield (DIVY), BETA, book-to-market ratio
(BTM), MV, TBA, MVTA, cash flows from operations (CFO) and asset growth
(TBAgr). The univariate relationships between RET and these independent variables
are in the same direction as the firm-level regression results presented below in section 5.
Consistent with prior research, the Pearson correlation of RET and the BTM ratio is
positive and all three size proxies, MV, TBA and MVTA, are negatively related to RET
and, as predicted in Berk (1997), CFO is positively correlated with both MV and TBA.
Moreover, the Pearson correlation coefficient between TBA and TBAgr is not statistically
significant at the 1% level and very close to zero, indicating that the two metrics are not
similar factors for future returns. Finally, there is a high correlation among all three size
proxy variables. For e.g., the Pearson correlation coefficient between MV and TBA is
0.820. Although the findings of this paper at the end of Section 5 reveal multicollinearity
among the three size proxies, this issue is addressed using a “differences in variables”
approach for the main model that reveals similar main findings, but without a serious
multicollinearity problem. Furthermore, the main objective of this paper is to ascertain
whether the overall explanatory power of a predictive returns model increases with
additional size proxy variables, rather than with its individual components.

5 Empirical analysis of value relevance of firm size proxies

5.1 Value relevance: Firm-level

The value relevance of the three firm size proxies is determined from the goodness of fit
(adjusted R2) obtained from Fama and MacBeth (1973) cross-sectional regressions.10
To test for value relevance, I regress firms’ one-year-ahead realized returns on their
dividend yield, CAPM beta, ratio of book to market equity and each firm size proxy
using Eq. (1) below:

RET i;tþ1 −RF tþ1 ¼ α þ β1 DIVY i;t þ β2 BETAi;t þ β3 LnBTM i;t þ β 4 LnSIZEi;t þ εi;tþ1 ð1Þ

Where:

m∏
RET m + 11 [1 + Rm,i]-1 |Rm is the monthly cum dividend return from CRSP of
firm i for month m; the return cumulation period starts in the fourth month
after fiscal-year end.
RF annualized one-month Treasury bill rate (from Ibbotson Associates), ob-
tained from the Fama and French website;

10
Value relevance has also been determined by the value and statistical significance of the coefficient on an
independent variable (e.g., Easton et al. 1992; Jenkins et al. 2009; Jones and Smith 2011). This determinant of
value relevance is positively related to the adjusted R2. Nevertheless, in this study I only use the adjusted R2 as
the determinant of value relevance because of its superiority when examining more than one variable and
because it is not influenced by the scale of the variables.
Journal of Economics and Finance (2020) 44:434–457 443

DIVY dividend yield [Compustat item DVYDF] for firm i;

BETA capital asset pricing model (CAPM) beta; BETA is estimated from a
regression of 48 monthly raw returns on the CRSP value-weighted monthly
stock returns up to the last month of fiscal-year t for firm i;
LnBTM the natural logarithm of the inverse of the price to book ratio [Compustat
item MKBKF] fiscal year-end for firm i;
LnMV the natural logarithm of market value, in millions, of common stock
obtained from CRSP for firm i;
LnTBA the natural logarithm of total book assets [Compustat item AT], in millions,
fiscal year-end for firm i;
LnMVTA the natural logarithm of market value plus total liabilities [Compustat item
TL] in millions for firm i;
The last three variables are the size proxies to be tested as SIZE in Eq. (1).
The CAPM beta and the ratio of book to market equity (BTM) are included in all
models to control for firm-level systematic risk and growth, respectively.11 Although
Fama and French (1992) and Cochrane (1999) find BETA to be insignificant when
stocks are first sorted by MV at the portfolio-level, BETA is included as an independent
variable because, a priori, it could be significant when using TBA or MVTA as the size
proxy and value relevance testing in this study is performed at the firm-level. Dividend
yield is also included as a control because of its wide use as an explanatory variable for
returns. Powell et al. (2009, p. 337) state that, “Dividend yield is probably the best-
known of the many variables that are found to have stock return forecasting power, with
Cochrane (1999, p. 37) labelling it ‘one of the new facts of finance’.” In addition, Ince
and Owers (2012) find dividend payout policy especially important in valuation models
because of the differential tax treatment of dividends and capital gains in the USA.

5.2 Relative value relevance: Firm-level

The Fama and MacBeth (1973) cross-sectional regression results of Eq. (1), for fiscal
years 1989–2015, are shown in columns 0 to 4 of Table 2 (Panel A).12 Column 0
presents the results without any size variables. The coefficient on variable BETA (β2) is
statistically insignificant in all columns of Table 2 and the coefficient on variable
LnBTM is positive, as expected, but only statistically significant in columns 0, 1, 2
and 3. It becomes statistically insignificant when both market value (MV) and total
book assets (TBA) are used in the same model. Unsurprisingly, column 0 has the lowest
adjusted R2 (3.20%). Next, column 1 shows how the results change when MV is added
11
The predicted direction of the BTM ratio with future stock returns is positive. Lakonishok et al. (1994)
provide a behavioural explanation for the positive relationship. Investors are overly pessimistic about low-
growth stocks, proxied by the BTM ratio, but as the growth rates mean revert in the future, investors are
surprised by the positive performance, resulting in higher returns. A risk based explanation, provided by Fama
and French (1992), is that high BTM ratio stocks have a higher probability of bankruptcy relative to high-
growth stocks. Nevertheless, they do not rule out the above behavioural explanation.
12
Fama and MacBeth (1973) regressions are used to allow equal weights for all fiscal years and the means of
all variables to change yearly, which helps to reduce any survivorship bias (Fama and French 2002, p. 15).
However, to be consistent with prior research evaluating value relevance (e.g., Jenkins et al. 2009;
Balachandran and Mohanram 2011), I also perform the same relative and incremental value relevance testing
using pooled cross-sectional regressions with clustered standard errors by firm and year to adjust for both
cross-sectional and serial correlation. The results are very similar to using annual Fama-Macbeth regressions.
444 Journal of Economics and Finance (2020) 44:434–457

to the main model. Consistent with prior research, LnMV has a negative coefficient
(β4 = −0.014) that is statistically significant at the 5% level. The size proxy LnMV also
increases the adjusted R2 of the model to 4.10%.
Column 2 shows the results of Eq. (1), but replaces LnMV with the natural log of
TBA (LnTBA). The coefficient on LnTBA (β4 = −0.007) is negative, but statistically
insignificant (p value = 0.240). Similarly, column 3 shows the results of Eq. (1) using
the natural log of the market value of TBA (LnMVTA), which also has a negative
coefficient (β4 = −0.009) and is statistically significant at the 10% level.13 The adjusted
R2 is 3.9% when using LnTBA and 3.8% when using LnMVTA., which is less than
when using the size proxy LnMV. Hypothesis development regarding the comparison of
the value relevance of these three size proxies was presented in the null form, i.e., there
is no difference in value relevance provided by these three firm-size proxies. The results
set out above reject hypothesis 1 because MV as the size proxy provides higher relative
value relevance in the return prediction model, Eq. (1), compared with the other two
size proxies. However, in section 6, additional testing is performed using only upper
quartile MV firms. For these larger firms, TBA provides slightly higher value relevance,
suggesting that TBA may be a better firm-size proxy for larger firms. These differences
are statistically significant at the 1 % level using the Vuong (1989) model selection
test.14

5.3 Incremental value relevance: Firm-level

The incremental value relevance of adding LnTBA to a future returns model that already
contains LnMV is shown in Table 2 (Panel A), column 4. Using two firm-size proxies
provides the highest explanatory power for the model, with an adjusted R2 of 5.2%.
Therefore, the addition of LnTBA to the model that already contains LnMV increases the
explanatory power by 26.8% (4.1 to 5.2%), which is the incremental value relevance of
TBA and statistically significant at the 1% level.15 Hypothesis 2, that LnTBA would
increase value relevance when included in a model with LnMV, is supported. This
finding is important because any increase in return prediction will lead to better
resource allocation decisions by investors and improve future research in asset
pricing. Rapach and Zhou (2013, p. 330) note that academics are interested in stock
return forecasting because of its implications for tests of market efficiency and for

13
“Berk (1995) analytically shows that the relationship of future returns with MV is due to an endogenous
relationship rather than some firm-level factors. Since TBA are highly correlated with MV, the reader is
cautioned of a potential endogenous relationship of future returns with TBA. In section 6, robustness testing is
performed by including a battery of additional variables known to be related to stock returns. The findings
obtained using these extra variables are qualitatively similar to the main findings set out in Table 2.
14
For computing Vuong’s Z-statistic, the predicted values for each model are obtained using the MLE
procedure MIXED in SAS. The SAS code used for calculating the Vuong statistics was obtained from the
SAS Institute and can be found at http://support.sas.com/kb/42/addl/fusion_42514_6_vuong.sas.txt.
15
To test the statistical significance of this difference or incremental value relevance, I do not use the Vuong
(1989) test because it is not recommended for comparing nested models and should not be used for nested
models that are correctly specified (Wooldridge 2010, p. 506). Equation (1) with only LnMV is a nested model
of Equation (1) with LnTBA added to it. Therefore, I test the statistical significance of the increase in
explanatory power by using a simple F statistic that compares the two adjusted R2s, as presented in
Gujarati (2003 p. 263). The F statistic is [(R2new – R2old)/df1] / [(1- R2new)/df2], where “new” is the model
with the additional variable and df1 is the number of new regressors and df2 is the sample size less the number
of parameters in the new model.
Table 2 Firm-level annual regressions: predictive power of firm-size proxies

Panel A Equation (1): RETi,t + 1 – RFt + 1 = α + β1DIVYi,t + β2 BETAi,t + β3 LnBTMi,t + β4 LnSIZEi,t + εi,t + 1
Variable Prediction (0) (1) (2) (3) (4)
Coefficient Coefficient Coefficient Coefficient Coefficient
intercept 0.147*** 0.219*** 0.185*** 0.199*** 0.194***
(3.56) (3.19) (2.97) (3.09) (3.14)
DIVY – −0.378 −0.053 −0.142 −0.095 −0.375*
-(1.00) -(0.20) -(0.61) -(0.38) -(1.83)
BETA + 0.009 0.008 0.008 0.008 0.007
(0.57) (0.52) (0.52) (0.52) (0.52)
LnBTM + 0.048*** 0.035** 0.047*** 0.041** 0.002
(2.96) (2.46) (2.88) (2.64) (0.19)
Journal of Economics and Finance (2020) 44:434–457

LnMV – −0.014** −0.058**

-(2.12) -(2.76)
LnTBA – −0.007 0.044**
-(1.20) (2.34)
LnMVTA – −0.009
-(1.61)
Average observations/yr 2,777 2,777 2,777 2,777 2,777
Adjusted R-squared 3.20% 4.10% 3.90% 3.80% 5.20%

Panel B Equation (1) with future return period starting in the 7th. month after fiscal year end
Variable Prediction (0) (1) (2) (3) (4)
Coefficient Coefficient Coefficient Coefficient Coefficient
intercept 0.147*** 0.209*** 0.174*** 0.192*** 0.189***
(4.25) (3.82) (3.55) (3.66) (3.76)
445
Table 2 (continued)
446

DIVY – −0.346 −0.169 −0.227 −0.181 −0.463*

-(0.92) -(0.56) -(0.91) -(0.65) -(1.91)
BETA + 0.002 0.001 0.001 0.001 0.000
(0.15) (0.06) (0.08) (0.09) (0.00)
LnBTM + 0.042*** 0.032** 0.041*** 0.037** 0.004
(3.23) (2.42) (3.16) (2.75) (0.32)
LnMV – −0.012* −0.051**
-(1.80) -(2.76)
LnTBA – −0.005 0.039**
-(0.88) (2.49)
LnMVTA – −0.008
-(1.32)
Average observations/yr 2,674 2,674 2,674 2,674 2,674
Adjusted R-squared 2.30% 3.30% 2.90% 3.10% 4.30%

This table presents coefficients from Fama and MacBeth (1973) cross-sectional regressions of one-year-ahead returns on the variables shown. *, **, and *** denote significance at the
10%, 5%, and 1% levels, respectively, and in parentheses are Fama-MacBeth t-statistics. All US firms traded on the NYSE, AMEX, and NASDAQ exchanges, excluding firms in the
financial industry, are used. For inclusion in the base sample, firms must also have available data for the variables in the main regression model- Eq. (1), resulting in 74,989 observations
over the sample period 1989–2015. RET-RF, dependent variable, is the annualized cum-dividend one-year-ahead return less the risk free rate obtained from the CRSP monhtly stock file
and the Fama and French website, respectively. DIVY is the dividend yield, BETA is the CAPM beta, calculated for each firm-year using the preceding 48 month returns and CRSP value
weighted market returns. LnBTM is the natural logarithm of the book-to-market ratio. LnMV and LnTBA are the natural logarithms of market value and total book assets, respectively.
LnMVTA is the naturual logarithm of (MV + total liabilites).
All continuous variables are winsorized at 1% and 99% of their respective distributions.
Journal of Economics and Finance (2020) 44:434–457
Journal of Economics and Finance (2020) 44:434–457 447

better asset pricing models. Furthermore, using the method derived in Campbell and
Thompson (2008, p.1524), the above absolute increase in R2 of 1.1%, as a result of
adding TBA, is approximately a 1 % increase in portfolio returns for a mean-variance
investor. This increase would be desirable given the minimal effort to find and add TBA
to any model and Campbell and Thompson mention that even small increases in the
adjusted R2 provide large economic benefits to investors.

5.4 Extended return prediction period

The future 12 month return cumulation period begins in the fourth month after the fiscal
year-end because the Securities and Exchange Commission allows financial statements
to be filed within three months after the fiscal year-end. This is consistent with prior
research and ensures that the date for MV is not too far from the date of TBA. Still, some
studies allow six months after fiscal year-end before the start of the return cumulation
period (e.g., Fama and French 1992; Cooper et al. 2008). In this case, a firm with a
December fiscal year-end would have its return period from July 1 to June 30 of the
following year. Although using six months after fiscal-year end makes MV less
comparable to TBA, I still run Eq. (1) using this starting point for the return period to
assess any differences. Consistent with the main findings of this study, Table 2 (Panel
B) shows the order of explanatory power change parallels the findings to returns
beginning in the fourth month after the fiscal year-end. The adjusted R2 is 3.3%
when only including LnMV as the size proxy, and increases to 4.3% when both
LnMV and LnTBA are included, an increase of 30.3%.
In summary, the firm-level findings show higher relative value relevance for
MV compared to TBA and MVTA, but TBA provides the higher value relevance
for upper quartile MV firms. Examination of relatively large firms is common
in corporate governance, audit and employee compensation studies. Therefore,
TBA could be the better size proxy compared to MV for these studies resulting
in different findings. Furthermore, significant incremental value relevance oc-
curs by adding TBA to a returns model that already includes MV. The benefits
of incremental value relevance are important because returns models are often
used in financial research and any increase in explanatory power will likely increase
market efficiency since investors are better informed to make resource allocation
decisions (Givoly et al. 2017).
Multicollinearity is likely present between TBA and MV because they are highly
correlated (Table 1, Panel B). However, multicollinearity is not a serious issue
for this study because the models are being tested for their overall predictive
ability when changing or adding a firm-size proxy and not for the value and
statistical significance of an individual size proxy coefficient. I also perform
analysis of Eq. (1) with all of its variables as first differences and a transfor-
mation of TBA when used with MV. In untabulated results, the incremental value
relevance findings of Table 2 (Panel A) are maintained, but without a major
multicollinearity problem between TBA and MV.16

16
Near multicollinearity does not violate the OLS BLUE properties, in which case the regression estimators
are unbiased but with large standard errors (Pearce and Reiter 1985; Gujarati 2003). However, if one of the
size variables is dropped, then a more serious problem of misspecification may lead to biased estimators.
Table 3 This table presents coefficients from Fama and MacBeth (1973) cross-sectional regressions of one-year-ahead returns on the variables shown.
448

Firm-level annual regressions: predictive power of firm-size proxies & extensive controls variables
Panel A Equation (1):RETi,t + 1 – RFt + 1 = α + β1 DIVYi,t + β2 BETAi,t + β3 LnBTMi,t + β4 LnSIZEi,t + βk Ci,t + εi,t + 1
Variable Prediction (0) (1) (2) (3) (4) (5) (6)
Coefficient Coefficient Coefficient Coefficient Coefficient Coefficient Coefficient
intercept 0.194*** 0.252*** 0.195*** 0.195*** 0.193*** 0.190*** 0.282***
(3.27) (2.78) (3.45) (3.29) (3.30) (3.21) (3.00)
DIVY – −0.440** −0.454** −0.479** −0.440** −0.436** −0.438** −0.472**
-(2.24) -(2.31) -(2.25) -(2.24) -(2.19) -(2.26) -(2.27)
BETA + 0.006 0.007 0.007 0.006 0.006 0.002 0.004
(0.39) (0.45) (0.47) (0.39) (0.38) (0.15) (0.30)
LnBTM + 0.000 0.004 −0.001 0.000 0.001 0.001 0.007
-(0.02) (0.47) -(0.17) -(0.03) (0.12) (0.14) (0.81)
LnMV – −0.059** −0.054** −0.061*** −0.059** −0.057** −0.050** −0.043**
-(2.76) -(2.53) -(2.84) -(2.75) -(2.72) -(2.72) -(2.66)
LnTBA + 0.046** 0.040** 0.046** 0.045** 0.044** 0.037** 0.028*
(2.39) (2.13) (2.43) (2.37) (2.34) (2.19) (1.95)
LnDTAT – 0.009 0.012
(0.78) (1.20)
ROA ? 0.029 0.055
(0.40) (0.77)
ROS ? 0.000 0.000
(0.27) -(0.69)
Eyld ? −0.031 −0.040**
-(1.08) -(2.16)
RETlag – −0.028 −0.028
-(1.00) -(1.04)
Average observations/yr 2,456 2,456 2,456 2,456 2,456 2,456 2,456
Adjusted R-squared 5.30% 5.40% 5.90% 5.30% 5.40% 5.80% 6.60%
Journal of Economics and Finance (2020) 44:434–457
Table 3 (continued)
Cross-Sectional annual regressions of one-year-ahed returns on TBA and other stock mispricing variables
Panel B Equation (2):RETi,t + 1 –RFt + 1 = α + β1 DIVYi,t + β2 BETAi,t + β3 LnBTMi,t + β4 LnMVi,t + β5 LnTBAi,t + β6 Accrualsi,t + β7 TBAgri,t + εi, t + 1
Variable Prediction (0) (1) (2) (3) (4)
Coefficient Coefficient Coefficient Coefficient Coefficient
intercept 0.202*** 0.192*** 0.203*** 0.193*** 0.240**
(3.40) (3.29) (3.42) (3.33) (2.51)
DIVY – −0.443** −0.450** −0.503** −0.504** −0.580***
-(2.27) -(2.23) -(2.57) -(2.50) -(2.87)
BETA + 0.009 0.007 0.010 0.008 0.007
(0.51) (0.45) (0.57) (0.51) (0.48)
LnBTM + −0.001 0.003 −0.003 0.001 0.003
Journal of Economics and Finance (2020) 44:434–457

-(0.07) (0.38) -(0.36) (0.10) (0.38)

LnMV – −0.060*** −0.056** −0.058** −0.055** −0.044**
-(2.81) -(2.66) -(2.78) -(2.64) -(2.75)
LnTBA + 0.045** 0.042** 0.044** 0.041** 0.030*
(2.33) (2.18) (2.31) (2.17) (2.03)
Accruals – −0.178*** −0.164*** −0.171***
-(3.49) -(3.28) -(4.23)
TBAgr – −0.037*** −0.034*** −0.037***
-(4.53) -(4.30) -(4.67)
LnDTAT – 0.004
(0.43)
ROA ? 0.095
(1.33)
449
Table 3 (continued)
450

ROS ? 0.000
-(0.85)
Eyld ? −0.024
-(1.17)
RETlag – −0.025
-(0.96)
Average observations/yr 2,374 2,374 2,374 2,374 2,291
Adjusted R-squared 5.50% 5.80% 5.70% 6.00% 7.40%

*, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively, and in parentheses are Fama-MacBeth t-statistics. All US firms traded on the NYSE, AMEX, and
NASDAQ exchanges, excluding firms in the financial industry, are used. For inclusion in the base sample, firms must also have available data for the variables in the main regression
model- Eq. (1). RET-RF, dependent variable, is the annualized cum-dividend one-year-ahead return less the risk free rate obtained from the CRSP monhtly stock file and the Fama and
French website, respectively. DIVY is the dividend yield, BETA is the CAPM beta, calculated for each firm-year using the preceding 48 month returns and CRSP value weighted market
returns. LnBTM is the natural logarithm of the book-to-market ratio. LnMV and LnTBA are the natural logarithms of market value and total book assets, respectively. The additional
control variables are: LnDTAT is natural logarithm of total debt to total assets, ROA is EBIT divided average total assets, ROS is total sales divided average total assets, Eyld is earnings
per share divided by prior year price, and RETlag is one year lagged returns. Firm-year observations reduce to 66,318 in Panel A due to data requirements of additional variables and
LnDTAT equals zero if DTAT = 0. In Panel B, firm-year observations reduce to 64,102 due to data requirements for Accruals and TBAgr. Both Panels are for 1989–2015.
All continuous variables are winsorized at 1% and 99% of their respective distributions.
Journal of Economics and Finance (2020) 44:434–457
Journal of Economics and Finance (2020) 44:434–457 451

6 Robustness testing and limitations

6.1 Stock miss-pricing and additional control variables

To provide greater assurance that the increase in value relevance is related to TBA, I test
the main equation of the paper, Eq. (1), by adding an extensive number of other
common control variables used in returns models to mitigate omitted variable bias. In
Table 3 (Panel A), the coefficient and statistical significance of TBA is robust to adding
the natural log of debt-to-total assets (LnDTAT), return on assets (ROA), return on sales
(ROS), earnings yield (Eyld), or lagged returns (RETlag).17 In all cases, TBA provides
the highest incremental value relevance to a model that already contains MV.
Moreover, these additional variables are statistically insignificant when individ-
ually added or altogether to Eq. (1), except for Eyld. Eyld is statistically
significant in column 6 with all the control variables. However, the incremental
value relevance of Eyld is negligible compared to TBA. In untabulated results,
the adjusted R2 for column 1 is 4.3% if TBA are replaced by Eyld. The superiority of TBA
over ROA and Eyld is notable because earnings are a key item for predicting stock
returns by academics and security analysts.
Finally, two common stock mispricing anomalies that involve TBA are the accruals
anomaly (accruals are part of TBA) and the asset growth anomaly (Sloan 1996; Palmon
et al. 2008; Cooper et al. 2008; Lam and Wei 2011). The former anomaly finds deflated
working capital accruals negatively related to future returns and the latter finds growth in
assets negatively related to future stock returns. To examine if TBA are just a manifestation
of these two stock mispricing factors, I add working capital accruals (Accruals) and asset
growth (TBAgr) to Eq. (1) resulting in Eq. (2), which is presented below.

RET i;tþ1 −RF tþ1 ¼ α þ β 1 DIVY i;t þ β2 BETAi;t þ β3 LnBTM i;t þ β4 LnSIZEi;t
þ β4 LnMV i;t þ β5 LnTBAi;t þ β6 Accrualsi;t þ β 7 TBAgri;t

þ εi;tþ1 ð2Þ

The Fama and MacBeth (1973) multiple regression findings are presented in Table 3
(Panel B). Column 1 shows that by adding working capital accruals, the coefficient on
TBA remains almost unchanged. The same conclusion holds in Column 2, where asset
growth is added to Eq. (1). Column (3) presents Eq. (2) with both size proxies, working
capital accruals, and asset growth. Once again, the coefficient on LnTBA is statistically
significant and is only marginally smaller than without these two additional variables
(0.045 to 0.041). Therefore, it is unlikely that TBA are picking up the stock mispricing
associated with accruals and asset growth. Finally, to provide greater assurance of
minimizing the omitted variable problem, I run Eq. (1) with the addition of both the
mispricing variables and all the control variables from Panel A of Table 3. Again, the

17
LnDTAT is the natural logarithm of total debt to tangible assets, ROA is earnings before interest and taxes
(EBIT) divided by average TBA, ROS is EBIT divided by TBA, Eyld is earnings per share divided by prior year
price, and RETlag is one year lagged returns. LnDTAT ratio is included because I suspect that the book-to-
market ratio, in Equation (1), is not fully controlling for leverage since that ratio can vary even for a firm with
no debt. The logarithm of ROA, ROS, and Eyld is not taken because they are often negative.
Table 4 This table presents coefficients from Fama and MacBeth (1973) cross-sectional regressions of one-year-ahead returns on the variables shown.
452

Firm-level annual regressions: Firm-year observations in upper quartile MV only

Panel A Equation (1): RETi,t + 1 – RFt + 1 = α + β1 DIVYi,t + β2 BETAi,t + β3 LnBTMi,t + β4 LnSIZEi,t + εi,t + 1
Variable Prediction (0) (1) (2) (3) (4)
Coefficient Coefficient Coefficient Coefficient Coefficient
intercept 0.087** 0.043 0.015 0.009 0.042
(2.51) (0.61) (0.27) (0.14) (0.61)
DIVY – 0.075 −0.002 −0.078 −0.064 −0.149
(0.17) (0.00) -(0.20) -(0.15) -(0.47)
BETA + 0.009 0.009 0.010 0.010 0.007
(0.44) (0.46) (0.50) (0.50) (0.38)
LnBTM + 0.009 0.011 0.004 0.009 −0.002
(0.64) (0.83) (0.26) (0.67) -(0.21)
LnMV – 0.006 −0.011
(0.85) -(0.57)
LnTBA – 0.008 0.016
(1.37) (0.95)
LnMVTA – 0.009
(1.54)
Average observations/yr 694 694 694 694 694
Adjusted R-squared 5.70% 6.30% 6.40% 6.20% 7.50%

Firm-level annual regressions: Recent time period of years 2006–2015

Panel B
Variable Prediction (0) (1) (2) (3) (4)
Coefficient Coefficient Coefficient Coefficient Coefficient
Journal of Economics and Finance (2020) 44:434–457
Table 4 (continued)
intercept 0.103 0.137 0.080 0.094 0.098
(1.40) (1.19) (0.89) (0.99) (1.03)
DIVY – 0.409 0.432 0.279 0.338 −0.018
(1.12) (1.02) (0.74) (0.86) -(0.07)
BETA + 0.006 0.005 0.006 0.006 0.000
(0.23) (0.21) (0.23) (0.23) (0.01)
LnBTM + 0.033 0.027 0.032 0.033 −0.026**
(1.15) (1.19) (1.13) (1.21) -(3.17)
LnMV – −0.006 −0.076
-(0.69) -(1.76)
LnTBA – 0.004 0.070*
Journal of Economics and Finance (2020) 44:434–457

(0.71) (1.90)
LnMVTA – 0.001
(0.24)
Average observations/yr 2,722 2,722 2,722 2,722 2,722
Adjusted R-squared 2.40% 3.00% 2.80% 2.80% 4.80%

*, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively, and in parentheses are Fama-MacBeth t-statistics. All US firms traded on the NYSE, AMEX, and
NASDAQ exchanges, excluding firms in the financial industry, are used. For inclusion in the base sample, firms must also have available data for the variables in the main regression
model- Eq. (1): dividend yield (DIVY), natural logarithm of the book-to-market ratio (LnBTM), and size proxy variables. The restriction to only upper quartile MV firms in Panel A
results in 18,750 firm-year observations over the sample period 1989–2015 and including only the last 10 years of the sample period reduces the firm-year observations to 27,227.
All continuous variables are winsorized at 1% and 99% of their respective distributions.
453
454 Journal of Economics and Finance (2020) 44:434–457

coefficient on LnTBA (Panel B, column 4) is statistically significant but smaller than

without all of the control variables added from Panel A (0.041 to 0.030), although still
larger than without the additional mispricing variables of accruals and asset growth.
The coefficient on LnTBA is 0.028 in Table 3 (Panel A).

6.2 Value relevance using only large firms and during latter sub-sample period

The MV size premium has been primarily associated with small MV firms (e.g., Banz
1981; Fama and French 1995; Knez and Ready 1997; van Dijk 2011; Docherty et al.
2013), though no examination has been undertaken to ascertain how future returns are
related to TBA for large MV firms. This analysis is useful because many studies in
accounting and finance use only large MV firms (e.g., corporate governance, audit and
executive compensation) and the relative illiquidity of small-cap firms prevents imple-
mentation of some trading strategies and limits risk management (Docherty et al. 2013).
Consequently, I re-run Eq. (1) using only firms with annual MV in the upper quartile, and
the findings are presented in Table 4 (Panel A). The use of MV and TBA, individually or
jointly in the same model, is statistically insignificant and is consistent with prior research
that the size effect is primarily in small firms. Nevertheless, over the 27-year sample
period of 1989 to 2015, TBA as the size proxy provides slightly greater explanatory
power (6.4%, Column 2) for the model than using MV (6.3%, Column 1). Potentially for
large firms, TBA maybe the better size proxy control variable. Furthermore, similar to the
main findings of the paper, the highest explanatory power is achieved when using both
size proxies. Column 4 shows an adjusted R2 of 7.5%, which represents a 19.1% increase
in explanatory power over using MV as the only size proxy.
Some papers have reported a decline in or disappearance of the size premium in
recent time periods (see van Dijk 2011). Therefore, I also investigate whether the value
relevance results of section 5 still hold in more recent years of the sample period of this
study. Table 4 (Panel B) presents the value relevance results of Eq. (1) using only the
latter 10 year sample period of years 2006 to 2015. Once again, the highest explanatory
power for the model is achieved when including both size proxies LnMV and LnTBA.
Column 4 shows an adjusted R2 of 4.8%, which represents a 60.0% increase in the
explanatory power (or incremental value relevance) over using only LnMV in the model.

6.3 Limitations

As in any study that uses an asset pricing model, there is concerns about whether the
model being used is correctly specified and about endogeneity. I mitigate this issue by
performing extensive testing using additional variables. I mitigate this issue by
performing extensive testing using additional variables. Moreover, this study does
not purport that market value, total book assets, or market value of total assets are
the only firm size proxies.

7 Conclusion

Using a sample of 74,989 firm-year observations over the 27-year period from 1989 to
2015, I test the value relevance of three firm size proxies: market value (MV), total book
Journal of Economics and Finance (2020) 44:434–457 455

assets (TBA) and an estimate of the market value of total book assets (MVTA). The
findings support MV providing higher relative value relevance over TBA or MVTA as
the sole size proxy in firm-level predictive returns models, but TBA provide higher
value relevance when examining only large firms. Moreover, an increase in explanatory
power of approximately 27% is achieved when both MV and TBA are included in the
same predictive returns model. The increase in explanatory power is 60% when
examining only the last 10 years of the sample period.
Returns models used in accounting and finance studies often only use MV as the size
proxy, so the increase in value relevance from using other proxies is likely to improve
future research related to capital markets. In addition, the increase in stock return
predictability will provide investors the potential to make better resource allocation
decisions leading to higher risk adjusted returns.

Acknowledgements I thank Douglas Hannah, Merridee Bujaki, Sarah Dyce, Eric Johnson, Raj Mashruwala
(discussant), Bruce McConomy, Steven Murphy, Karin Petruska, Robert Resutek (discussant) and Ralph
Winter for their valuable suggestions. The paper has also benefited from comments received at the 2015 Telfer
(U. of Ottawa) annual conference on accounting and finance, the 2014 Canadian Academic Accountants
Association annual conference, the 2013 AAA annual conference and the 2013 AAA Mid-Atlantic region
conference. Any errors or omissions are my own.

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