The Feltham-Ohlson (1995) Model: Empirical Implications

This paper develops empirical implications of the Feltham and Ohlson (1995) model, which relates a firm's market value to accounting data and their expected realizations. The key issue concerns how one conceptualizes/measures a firm's expected growth to explain its market value when the model also includes more basic accounting measures reflecting its current performance. It is shown that market value can be expressed in terms of (1) financial assets (liabilities) with a coefficient of 1, (2) the expected change in operating earnings with a nonnegative coefficient, (3) the expected operating earnings with a positive coefficient, (4) current (net) operating assets with a nonnegative coefficient, and (5) the expected change in (net) operating assets with a positive coefficient. One identifies the measure of a firm's expected growth by normalizing the last variable with current (net) operating assets. The variable will be relevant if and only if the accounting is conservative.