Accounting income, income components and market-to-book equity ratios: Finnish evidence

Abstract

Abstract This study provides new evidence on the relationship between various income-to-book and market-to-book equity ratios using Finnish data. Because of extremely wide earnings management possibilities that are tractable from published financial statements, Finland provides a unique environment to test the importance of income management in creating investors' cash flow expectations. The findings suggest that income statement items other than “bottom-line” earnings contain useful information when investors are creating cash flow expectations for Finnish firms. This holds especially for income components that can be regarded permanent. It also appears that the income management component of earnings has low value-relevance. This is the case also for extraordinary income/expenses, which can be regarded as transitory by nature. The findings of the study further suggest that in none of the various income levels investigated is negative accounting income significantly positively related to the market-to-book equity ratios. If income is positive, however, the positive relationship exists. These findings support the hypothesis that investors regard accounting losses as temporary, not reflecting future cash flow expectations. In general, the results of the study indicate that investors split accounting earnings into components and evaluate the value-relevancy of income statement items when creating cash flow expectations for firms.

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