Paths to Valuation, Asset Pricing, and Practical Investing: Can Accounting and Finance Approaches Be Reconciled?

Stephen Penman

Chapter 1 in Bridging the GAAP:Recent Advances in Finance and Accounting, 2012, pp 3-20 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractThis paper compares accounting and finance approaches to equity valuation, with a focus on practical investing. It shows how the two endeavors tie to the same theoretical foundation so they have the potential of being unified. Finance has largely focused on the "denominator" aspect of valuation — the discount rate — under the mantra of "asset pricing," while accounting has largely focused on the numerator — specifying the expected accounting outcomes to be discounted. The paper shows how both accounting and finance can be unified to resolve both the numerator and denominator issues in valuation. Important to this is an understanding of the book-to-price ratio, which finance sees as a denominator attribute indicating risk and expected return, while accountants see it as a numerator attribute. The paper shows how book-to-price features in both cases, in particular, how an appreciation of the accounting for book value provides an understanding of why book-to-price is related to risk and return.

Keywords: Finance; Accounting; Fair Value; Asset Prices; Options; Capital Structure; Debt; Inventory; Leverage; Incentive; Specialists; Generally Accepted Accounting Principles (GAAP) (search for similar items in EconPapers)
Date: 2012
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