The Search for a Superior Measure of Firm Performance: An Empirical Analysis Comparing the Value Relevance of Financial Performance Measures

Abstract

This thesis investigates the statistical association between various measures of financial performance and the market value of equity. Utilizing a sample of 352 firms from the S&P 500 over the period from 2014 to 2023, the study applies a quantitative methodology using panel data regression analysis. The aim is to shed light on the ongoing debate among scholars and practitioners on which performance measure best capture and summarise information relevant to investors when valuing a firm.This study distinguishes between three types of performance measures, namely residual income-based, cash flow-based, and traditional. Across categories, these measures consist of Residual Income (RI), Economic Value Added (EVA), Cash Value Added (CVA), Free Cash Flow to Equity (FCFE), Sustainable Earnings (SE), Return on Equity (ROE), and Net Income (NI). The findings are presented based on a ranking of the measures according to their value relevance, as indicated by the adjusted R² of the respective regression models. To support this ranking, the paper also tests whether the explanatory power of the models differs significantly from one another using the Vuong test. Overall, the findings indicate that among residual income- and cash flow-based measures, residual income-based measures performed best, with RI ranking first. However, the study did not find evidence that any of the residual income-based or cash flow-based measures outperformed the traditional accounting earnings measure, NI. Thus, a simple accounting earnings figure appears superior in contrast to more complex measures of firm performance.Finally, the analysis examined value relevance on an industry-specific basis. In many industries, it was not possible to determine with certainty whether the rankings differed significantly from the full sample. However, the findings did reveal with relative confidence that CVA was the most value-relevant measure in the Real Estate industry. Despite the ongoing debate and search for a single superior performance measure, these findings suggest that no single performance measure should be used for every situation.