The Effect of Macroeconomic Changes on the Value Relevance of Accounting Information:

The Case of Mexico and the 1995 Financial Crisis

Paquita Y. Davis-Friday
University of Notre Dame

Elizabeth A. Gordon*
Rutgers University

Current Draft: July 2002

Please do not quote without permission.

This paper has benefited from comments received from Chao-Shin Liu and participants at the
2002 European Accounting Association Annual Congress. Paquita Davis-Friday appreciates the
financial support of Ernst & Young, LLP and Elizabeth Gordon appreciates the financial support
from Rutgers University Summer Research Grants.

*Please address all correspondence to:

Elizabeth A. Gordon
Assistant Professor
Faculty of Management
Department of Accounting and Information Systems
Rutgers University
Janice H. Levin Building, Room 241
94 Rockafeller Road
Piscataway, NJ 08854
tel: 732.445.5849
The Effect of Macroeconomic Changes on the Value Relevance of Accounting Information:
The Case of Mexico and the 1995 Financial Crisis
ABSTRACT: Lev and Zarowin (1999) argue that the there has been a decline in the usefulness
of financial information in the U.S. resulting from the inability of the current financial reporting
system to contemporaneously capture changes in firms operations and economic conditions. As
a result, it appears that accounting information in the U.S. is not as timely as it could be. Francis
and Schipper (1999) suggest that the emphasis on objectivity and verifiability, which constrains
the early recognition of certain future economic benefits, is one reason U.S. financial statements
lack timeliness. The purpose of this research is to examine the value relevance of accounting
information in a setting where changes in general price levels and specific asset prices are
recognized periodically in the financial statements. Essentially, we investigate whether
accounting is more value relevant when it includes more relevant information. Additionally, we
examine whether the markets valuation of earnings and book values in this setting is affected by
an economic shock since continuous improvement of historical financial data (i.e., restatement)
should improve investors decisions (Lev and Zarowin 1999).
Using a sample of Mexican firms traded on the Mexican Stock Exchange (Bolsa) during
the period 1992-1997, we investigate the relation between the firms stock prices and their book
values, earnings, and cash flows, taking into account the effect of the 1995 Mexican financial
crisis. In pooled cross-sectional tests, we find that book values retain their significance and
explanatory power during the crisis while earnings do not. Additionally, the value relevance of
book values does not significantly change during the crisis period while the value relevance and
the explanatory power of earnings decline during the crisis period. The decline in the valuation
of earnings and its explanatory power, however, is attributable to the presence of negative
earnings. We attribute the lack of significant changes in the value relevance and explanatory
power of book values to the use of replacement costs and price level accounting in Mexico.
Finally, in additional analyses we find that the incremental value relevance of two components
of Mexican earnings, monetary gains and losses and exchange gains and losses, does not change
during the crisis implying that these features of Mexican accounting contribute to its continued
relevance during the crisis.
Key Words: Valuation; Mexico; Financial Crisis.
Data Availability: Data used in this study are available from public sources.
 I. INTRODUCTION

In this paper, we investigate whether the relevance of earnings, book values and cash

flows changes during an economy-wide financial crisis, the Mexican peso devaluation. Mexican

accounting practices (e.g., general price level adjustments and replacement cost accounting) and

the 1995 financial crisis provide a unique opportunity to investigate whether the effects of

economy-wide financial distress are tempered in an environment where accounting information

recognizes the effects of macroeconomic changes (i.e., monetary gains and losses, exchange

gains and losses and asset revaluations). The ability of the income statement to provide

information about the firms abnormal earnings opportunities may decline because of uncertainty

resulting from an economy-wide financial crisis, while the ability of the balance sheet to provide

information about the underlying asset values may be enhanced. As a change in the relevance of

earnings can be attributable to either a change in the relevance of cash flows or accruals, we also

examine changes in the relevance of disaggregated earnings.

Recent research suggests that the impact of change on firms operations and economic

conditions is not adequately reflected by the current reporting system in the U.S. (Lev and

Zarowin, 1999). Research at the firm and economy level has investigated changes in the

relevance of accounting measures when economic conditions change. Barth, Beaver, and

Landsman (1998) examine whether the value relevance of earnings and book values provided by

the current reporting system changes for a set of firms experiencing similar economic conditions.

They find that the value relevance and incremental explanatory power of book values (earnings)

increase (decrease) as the firms financial health decreases. Related studies explore the

relevance of accounting information during the Asian financial crisis and provide mixed results

on changes in the relevance of accounting information (Graham, King and Bailes, 2000; Ho, Liu,

1
and Sohn, 2001). These studies suggest that economic conditions affect the relevance of

accounting information; however, they provide inconsistent evidence implying that firms and/or

countries may be affected differentially by economic crisis. This study attempts to link the

recent literature on the value relevance of accounting information in the U.S. (Collins, Maydew,

and Weiss 1997; Ely and Waymire 1999; Francis and Schipper 1999; Lev and Zarowin 1999)

and prior research regarding the relevance, reliability and predictability of accounting

information produced by accounting systems that allow for more timely and relevant information

(Easton, Eddey and Harris 1993; Barth and Clinch 1996, 1998; Aboody, Barth, and Kasznik

1999).

We select the Mexican financial crisis, which started with the peso devaluation in

December, 1994, and continued through 1995, to investigate whether the relevance of book

values, earnings, and cash flows changes, on average, during an economy-wide financial crisis

for two main reasons. First, the Mexican financial crisis had an extreme and uncertain effect on

the Mexican economy leading us to believe that the value relevance of firms' accounting

information could change. The Mexican governments decision to allow the peso to float freely

against the U.S. dollar on December 22, 1994, led to the Mexican peso losing over 50% of its

value relative to the U.S. dollar and to an increase in the annual inflation rate from 7% in 1994 to

52% in 1995. The equity markets interpreted the currency devaluation as adverse economic

information resulting in the stock market decline of almost 50%.1 Our second reason to study

Mexico is that features of Mexican generally accepted accounting principles, such as general

price level accounting and replacement cost accounting, incorporate changes in the underlying

economic condition and performance in the financial statements in a timely manner (Davis-

2
Friday, 2001; Gordon, 2001). As Healy et al. (2001) assert, better accounting standards provide

more relevant accounting. Therefore, we believe that any changes we find in the value relevance

of accounting information likely are attributable to changes in the markets valuation of the

information rather than to the accounting system poorly measuring economic conditions or firm

performance during a crisis period.

The question of changes in the value relevance of accounting information during a crisis

is a question worth examining regardless of the outcome. If there is a decrease in the relevance

of Mexican financial statement data for stock prices, then we might conclude that Mexican

accounting information is not robust to macroeconomic shocks. If however, there were no

significant difference in the relevance of the accounting information during and outside of the

crisis, then this would provide evidence that the Mexican accounting model is timely in terms of

economic changes.

We use three different but complementary approaches to gauge changes in the value

relevance of book values, earnings and cash flows during the crisis period. First, we test whether

the magnitudes of coefficients on book values, earnings and cash flows during the crisis period

differ significantly from those in the non-crisis period. A significantly different coefficient on

earnings or cash flows during the crisis periods suggests that the market changes its assessment

of the persistence of the earnings or cash flow stream. A significantly different coefficient on

book values during the crisis periods indicates that the market has changed its valuation of

underlying net assets.

Second, we compare the overall and incremental explanatory power (R2) of book values,

earnings, and cash flows during and outside of the crisis period. This investigation provides

1 The effect is from its highest close in 1994 to its lowest close in February of 1995.
3
evidence on whether the overall relation between accounting measures and market values

changes during the crisis period. We also assess whether the percentage change in incremental

R2 is similar for all accounting measures or whether certain measures become more (or less)

incrementally relevant during the crisis period.

Third, we investigate and compare the relative value relevance of earnings, book values

and cash flows during and outside of the crisis period using Vuong tests (Vuong, 1989). We

perform this test to examine and compare the explanatory power of each of our primary

accounting measures separately. With this test, we also gauge whether certain measures become

more (or less) relevant during the crisis period relative to other measures.

We find that book values retain their significance and explanatory power during the crisis

while earnings do not. Additionally, the coefficient on book values does not significantly change

during the crisis period while the coefficient on and the explanatory power of earnings decline

during the crisis period. The decline in the valuation of earnings and its explanatory power,

however, is attributable to the presence of negative earnings. The coefficient on and the

explanatory power of cash flows also decline during the crisis period. We attribute the lack of

significant changes in the coefficient on book values and the explanatory power of book values

to the use of replacement cost and price level accounting in Mexico

Finally, relying on the unique financial statement line items resulting from Mexicos

application of general price level adjusted and replacement cost accounting, we investigate the

impact of the crisis on disaggregated earnings and book values. To explore the valuation

implications of the change in the exchange rate, we investigate the valuation of exchange gains

and losses, foreign currency denominated debt and foreign revenues. We find that exchange

gains and losses are not incrementally valued during the crisis, suggesting they will not persist.

4
Consistent with this conclusion, we find that short-term foreign currency denominated debt is

valued less negatively during the crisis years, implying that firms will benefit in the near-term by

paying off debt with a devalued currency. We find no significant difference in the valuation of

foreign revenues implying they are expected to be as persistent outside of the crisis. To explore

the leap in inflation rates, we exploit the fact that Mexican generally accepted accounting

principles require general price level accounting (GPLA) and examine the valuation of monetary

gains and losses and find that there is no difference in their valuation during the crisis. Finally,

we investigate the valuation of current cost accounting and find that the coefficient on the

current cost asset revaluation reserve is valued similarly to that on book value during the crisis.

Overall, these results indicate that Mexican book values and earnings did not lose their value

relevance as a result of the financial crisis, and that investors relied on the particular accounting

institutions in Mexico specifically designed to capture the effects of such a crisis.

The remainder of the paper proceeds as follows. The next section discusses related prior

research and the third section describes Mexican financial reporting institutions. The fourth

section describes the research design and sample, and the fifth section discusses the results. The

final section draws conclusions and summarizes the papers contribution.

II. BACKGROUND AND PRIOR RESEARCH

The U.S. Financial Reporting Model

Recently, researchers have called into question the decision usefulness of the U.S.

financial reporting model. For example, Lev and Zarowin (1999) report that the usefulness of

earnings, cash flows and book values has been deteriorating over the past 20 years. They

attribute the deterioration to changes in firms operations and economic conditions that are not

5
captured by the accounting measurement process in the U.S. If investors generally react to the

impact of change on business enterprises contemporaneously, then there will be an increasing

discrepancy between market and accounting values (Lev and Zarowin, 365). Lev and Zarowin

(1999) propose comprehensive capitalization of intangible investments and a systematic

restatement of financial reports as possible remedies for the mismatch between revenues and

costs. Francis and Schipper (1999) indicate that the concern over whether financial statements

have lost their relevance to investors has prompted several research and policy initiatives, like

those suggested by Lev and Zarowin (1999), whose goal is to improve financial reporting in the

U.S. by altering the current reporting model. Other recommendations for changing financial

reporting address the issue of the timeliness of financial reporting. Francis and Schipper (1999)

describe timeliness as the ability of financial statements to capture value-relevant events in the

same time period as they are reflected in share returns. Therefore, one reason U.S. GAAP

financial statements lack timeliness is the emphasis placed on objectivity and verifiability, both

of which mitigate against early recognition of certain future economic benefits (Francis and

Schipper 1999, 324).

This study is an extension of this line of research as it investigates an alternative general

price level adjusted and current cost reporting model and the value relevance of its outputs over

time. Additionally, we examine a time period when there is an economic crisis to ascertain

whether the Mexican financial reporting system produces accounting information whose value

relevance is robust to an extreme change in firms operations and economic conditions.

The Value Relevance of Accounting Information

The empirical evidence in the U.S. regarding the valuation roles of earnings and book

values shows that price-earnings and price-book ratios vary cross-sectionally and the value

6
relevance of other accounting information (e.g., cash flows) is dependent on these relations. For

example, Barth, Beaver, and Landsman (1998) investigate the impact of firms financial health

on the relative valuation roles of equity book value, a proxy for liquidation value, and earnings, a

tool for valuing equity. They show that the valuation coefficients and incremental explanatory

power of book value (earnings) are higher (lower) for firms facing bankruptcy and liquidation.

Hayn (1995) finds that the price-earnings relation is much weaker for firms reporting losses than

for those reporting profits. She attributes her results to the markets perception that losses are

transitory. Her evidence is also consistent with the possibility that earnings will lose their value

relevance if they are low enough to make liquidating the firm preferable to continuing

operations. Together, these studies suggest that the value relevance of book value arises both

from its role as a better proxy for expected future normal earnings for loss firms (consistent with

Ohlson (1995)) and its role as a proxy for liquidation value.

Finally, Cheng, Liu, and Schaefer (1996) examine the incremental role of cash flows in

firm valuation. They argue that the ability of cash flows from operations to explain security

returns may be conditional on the degree of earnings permanence. Using both the level of cash

flows and their changes from one period to the next, Cheng et al. (1996) find that the incremental

information content of cash flows from operations increases with declines in the permanence of

earnings. Barth, Beaver, and Landsman (1999) also provide evidence on the roles of the accrual

and cash flow components of earnings in equity valuation. Their results indicate that accruals

and cash flows each have significant incremental explanatory power in the valuation model that

also includes book value of equity and abnormal earnings. They also find that the valuation

coefficient on accruals and cash flows vary with the persistence of the components and their

ability to predict future abnormal earnings.

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Valuation and Economic Crisis

Empirical research on the relative valuation roles of earnings, book values, and cash

flows outside of the U.S., and the impact of financial distress on those roles, is primarily limited

to the Asian financial crisis. Two studies examine the firm-specific effects of the Asian financial

crisis in two countries severely affected by currency devaluations and stock market declines.

Graham, King and Bailes (2000) document a decline in the value relevance of both book values

and earnings in Thailand following the devaluation of the Thai Baht. Ho, Liu, and Sohn (2001)

find evidence that the value relevance of Korean earnings declines during the crisis and its

importance is replaced by cash flows from operations, but not book value of equity. Their

results hold for a sample of firms that report positive earnings throughout their sample period

(1995-1998) and also after controlling for the amount of foreign exchange translation gains and

losses included in earnings and book value. Both studies find that the decline in the relevance of

earnings remains after controlling for negative earnings. These studies suggest that countries

may be affected differentially by an economic crisis resulting from currency devaluations and

stock market declines.

In a related study, Johnson, Boone, Breach, and Friedman (2000) find that measures of

corporate governance, in particular the effectiveness of protection for minority shareholders,

explain the extent of exchange rate depreciation and stock market decline better than standard

macroeconomic measures during the Asian financial crisis in 25 emerging markets. They do not

however find any relation between the quality of accounting standards in the country and the

extent of the currencies depreciation.

Additionally, Swanson, Rees, and Juarez-Valdes (2001) investigate whether fundamental

analysis can provide incremental explanatory power beyond earnings in Mexicos inflationary

8
economy. Their results indicate that fundamental signals, especially measures of selling and

administrative expenses relative to sales, provide incremental explanatory power for annual

returns beyond that provided by earnings. They conclude that their fundamental signals provide

value relevant information about the effects of the December 1994 currency devaluation on the

markets expectation about changes in future cash flows.

We extend this body of literature by investigating the relative value relevance of book

values, earnings, and cash flows in Mexico around the time of a financial crisis. LaPorta et al.

(1996) classify Mexico in the French Commercial Code family of law. Therefore, we might

expect that earnings are not as timely in Mexico as in its common law counterparts. However,

financial statements may be a more timely and value-relevant source of information in Mexico

than in some common law countries where other types of information precedes financial

statements (e.g., analyst forecasts in the U.S.). Additionally, Mexican financial statements are

periodically adjusted for the effects of general price level and specific asset price changes. The

purpose of our research is to provide evidence about the role of current cost and GPLA

accounting information in equity valuation in Mexico around the time of the 1995 financial

crisis.

Barth et al. (1998) predict that because of the role of the balance sheet in providing

information on liquidation values and the role of the income statement in providing information

about the firms abnormal earnings opportunities, the value relevance and incremental

explanatory power of equity book value (earnings) will increase (decrease) as the firms

financial health decreases. We investigate whether during financial crisis, Mexican firms, which

report using GPLA and current cost accounting procedures, experience the same shift in the

valuation roles of book value and earnings

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 III. THE MEXICAN FINANCIAL REPORTING ENVIRONMENT

Until the middle 1970s, Mexican inflation rates were low enough that it was unnecessary

for the accounting profession to abandon the historical cost model for reporting financial

information. An initial attempt to recognize the effects of inflation occurred in 1979 when a new

accounting principle called for disclosing gains or losses resulting from holding non-monetary

assets and liabilities. The principle also required the creation of a special reserve account in the

equity section to comply with the concept of capital maintenance in financial terms. The new

accounting principle borrowed many of the features of the FASB's SFAS No. 33 on inflation

accounting, and it asked for additional disclosures without modifying the original historical data

recorded in the accounts. The new principle never received general acceptance and was

subsequently eliminated by the Mexican Accounting Principles Commission. When annual

inflation climbed to double digits in the early 1980s, reaching 160 percent in 1987, it became

imperative to have a mechanism to reflect the impact of inflation on a company's reported

operations. Thus, the accounting profession came up with a new standard that replaced historical

cost and included the adjustments for inflation within the body of the financial statements.

Mexican accounting standard B-10, on the effects of inflation, became compulsory for all

companies in 1984 and it has been amended five times since then. The standard is built around

three concepts, namely, the effect of inflation on the net monetary (assets minus liabilities)

position, the gains or losses resulting from holding non-monetary assets, and the preservation of

capital in financial terms. The principle requires firms to restate all financial data in monetary

units as of the end of the current reporting period and all comparative financial statements from

prior years must be restated to constant pesos as of the date of the most recent balance sheet.

10
 To adjust for inflation, companies can use a consumer price index published by the

central bank; this is the procedure preferred by the Mexican Institutes Committee on

Accounting Principles. Companies also have the option to restate the values of inventory and

fixed assets to current replacement costs. This was previously a prerequisite imposed by the

Mexican National Banking and Securities Commission requiring listed companies to periodically

restate physical assets according to valuations by registered independent property appraisers.

When this approach is used, the difference between the restated values and those that would

result if a general price index were applied is reported as a gain or loss in holding non-monetary

items. This special account is reported in the owners' equity section of the balance sheet. The

cost of sales and depreciation accounts in the income statement reflect values adjusted for

inflation, or the replacement values if the specific cost restatement option is selected. The

owners' equity accounts are also adjusted for the effect of changes in the general price index.

For consolidated financial statements, all the accounts of the controlled subsidiaries must be

inflation-adjusted prior to proceeding with consolidation.

An additional item that is unique to inflation accounting in Mexico is the "integral cost of

financing," which is disclosed in the income statement. This is the net result of the nominal

interest expense, the gain or loss due to price level changes on the company's net monetary

position, and the differences due to variations in exchange rates for the company's monetary

assets and liabilities denominated in foreign currencies. Capital maintenance in constant peso

units is achieved through inflation and exchange rate effects on earnings for the year, and

through the cumulative result of holding non-monetary items reported in a special account within

the owners' equity section of the balance sheet.

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 Reporting the inflation adjustments on the cost of financing is similar to the integral

correction method used until 1994 in Brazil, with the added benefit that the various elements

impacting that cost are separately disclosed in the Mexican accounting model. The consumer

price index published by the central bank is the inflation factor that is used, thus standardizing

the adjustment applied by all reporting firms and enhancing comparability among companies.

Mexico and the Financial Crisis

On December 22, 1994, Mexico experienced a severe currency devaluation resulting

from the Mexican governments decision to allow the peso to float freely against the U.S. dollar.

The peso lost over 50% of its value relative to the U.S. dollar and that led to an increase in the

annual inflation rate from 7% in 1994 to 52% in 1995. From its highest close in 1994 to its

lowest close in February of 1995, the stock market also declined almost 50%. As a result of the

economic crisis, the most exposed firms, primarily those with foreign currency denominated

debt, experienced large exchange losses and subsequently negative earnings. While the increase

in the general level of inflation did not have a large impact on the firms financial statements,

since Mexico uses general price level adjusted (GPLA) accounting practices, Mexicos use of

replacement cost accounting for fixed assets led to decreases in firms equity revaluation

reserves.

Research on the properties of Mexican accounting data is limited. Davis-Friday (2001)

finds that current cost accounting disclosures, and in particular holding gains, are value relevant

in periods of high and relatively low inflation and Gordon (2001) finds that price-level and

replacement cost accounting disclosures have incremental value relevance beyond historical data

in Mexico. Several recent finance studies investigate the informational efficiency of the

Mexican stock market (Bhattacharya et al. 1998) as well as the effect of specific institutional

12
details on Mexican stock prices (Domowitz et al. 1997, 1998). These studies document curious,

if not anomalous, stock market behavior for a sample of Mexican firms that calls into question

the link between fundamental information and firm value in the Mexican market. The purpose

of our research is to investigate the explicit relation between book value of equity and the

accrual and cash flow components of earnings and Mexican stock prices during and around the

Mexican financial crisis.

IV. RESEARCH DESIGN

The primary research question in this paper is whether the value relevance of information

produced from the Mexican accounting model, which includes adjustments for changes in the

general price level and replacement costs, is affected by a macroeconomic shock. To address

this question, we take three complementary approaches to examine the value relevance of

accounting information in Mexico around the 1995 financial crisis. Similar to Barth et al. (1998)

we test whether valuation coefficients on book value, earnings and cash flows are affected by the

financial crisis, whether the overall and incremental explanatory power of the valuation models

change during the crisis and whether the relative explanatory power of the variables changes

during the crisis.2 Our primary equation regresses market value of equity on the two summary

measures from the balance sheet and income statement, equity book value and earnings:

MVit = 0 + 1 BVit + 2 X it + eit (1)

where MVit is the year-end market value per share of company i at time t; BVit is the book value

per share of company i at time t; Xit is earnings per share of company i over the period ending at

time t; and eit is an error term. We estimate equation (1) for both the crisis and non-crisis periods,

13
primarily to examine if there are any changes in the overall and incremental explanatory power

of the model and each variable during the time periods.3 Following Kamin and Babsons (1999)

crisis dating system, we include both 1994 and 1995 in the financial crisis period in Mexico.

During a crisis period, expectations about future abnormal profitability and future growth

generally decline due to uncertainty regarding both a countrys response and each companys

ability to respond to the crisis. Therefore, we expect that the valuation coefficient on earnings

during the crisis period will be lower implying that future abnormal earnings are expected to be

lower. Because prior research indicates that negative earnings lower the magnitude of the

earnings coefficient, we also add an interactive variable for negative earnings as a control.

As uncertainty over future abnormal earnings and future growth increases, book values

may become more relevant. Prior research (Barth et al., 1998, Collins et al., 1997) discusses the

expectation of an inverse relation between the relevance of earnings and book values. The

motivation for this expectation is similar to that Barth et al. (1998) use for firms in deteriorating

financial health. As the likelihood of future abnormal profitability decreases, the valuation

multiple on book values increases. While prior research regarding U.S. firms suggests that the

valuation of earnings would decline while that of book value increases as firms face financial

distress or report negative earnings (Barth et al. 1998), evidence regarding Korean and Thai

firms affected by the Asian financial crisis is mixed. In Mexico, an increased valuation multiple

on book value in times of uncertainty may be likely because Mexican firms use replacement cost

accounting. If replacement cost accounting is reliable during times of uncertainty, the multiple

2 Barth et al. (1998) examine only the trade off between equity book value and earnings.
3 To test whether the valuation coefficients on book values and earnings during the crisis period differ significantly
from those in the non-crisis period we also estimate an equation where we interact the intercept, book values and
earnings with a bivariate variable taking the value of one in the years affected by the currency devaluation. We do
not present the results of this equation since they are the same as separately estimating equations for both periods.

14
on book values may be higher when future abnormal earnings are uncertain. An alternative

expectation is that the multiple on book values will not change during the crisis because tangible

assets are valued at replacement cost each period. Therefore, the information conveyed by book

values (in the presence of earnings) may be similar in all time periods. To summarize, we expect

the valuation coefficient on earnings to be lower during the crisis period. We also expect that the

valuation coefficient on book values will not decrease during the crisis period.

We also investigate whether there is a change in the overall and the incremental

explanatory power of earnings and book values during and outside of the crisis. If there is an

overall decrease in the explanatory power of Mexican financial statement data for stock prices,

then we might conclude that Mexican accounting information is not robust to macroeconomic

shocks. If however, there were no significant difference in the overall explanatory power of the

accounting information during and outside of the crisis, then this would provide evidence that

the Mexican accounting model is timely in terms of economic changes.

We next examine whether the incremental explanatory power of our variables of interest

changes in the crisis and non-crisis period. A shift in the incremental explanatory power of

earning to book values would be consistent with the Barth et al. (1998) bankruptcy model in the

U.S. However, if general price level and replacement cost adjustments overstate book values

and not earnings, then we might not see any shift or a shift from the valuation of book values to

earnings during the crisis.

We extend our analysis to examine changes in the valuation of cash flows during the

devaluation. Cheng et al. (1996) and Ho et al. (2001) provide evidence that as earnings become

more transitory (negative) in the U.S. and Korea, respectively, the market values cash flows from

operations as a significant determinant of firm value. Therefore we perform analyses to examine

15
whether the valuation of cash flows differs for Mexican firms during the peso crisis. We expect

that during a devaluation the valuation multiple on cash flows will be higher. Even though the

value of the Mexican currency is decreasing and firms experience monetary losses from holding

cash, cash flows coming into the firm today are available to reinvest in the firm. Therefore, the

multiple on cash flows is expected to be greater during the crisis period because the cash can be

reinvested in the firm.

To test for a difference in the valuation of cash flows during the crisis, we separate

earnings into a cash flow component and accruals component:

MVit = 0 + 1 BVit + 2 CFOit + 3 ACCRit + e' it (2)

where CFOit is cash flows from operations per share of company i at time t; and ACCRit is

accruals per share (Xit CFOit) of company i at time t; and eit is an error term. We estimate

equation (2) for the both crisis and non-crisis period, primarily to examine if there are any

changes in the overall and incremental explanatory power of the model and each variable during

the two time periods.4 We expect the coefficients on BVit, CFOit and ACCRit, to be positive

during both the crisis and non-crisis periods. However, we expect that the valuation coefficient

on cash flows will be higher during the crisis.

Our third set of tests investigates the relative explanatory power of earnings, book values

and cash flows during the crisis and outside of the crisis. We use Vuong tests for non-nested

models and F-tests for nested models to compare the R2 from regressions where we separately

4 To test whether the valuation coefficients on book values, operating cash flows and accruals during the crisis
period differ significantly from those in the non-crisis period we also estimate an equation where we interact the
intercept, book values, operating cash flows and accruals with a bivariate variable taking the value of one in the
years affected by the currency devaluation. We do not present the results of this equation since they are the same as
separately estimating equations for both periods.

16
test the relation between MVit and BVit, Xit, and CFOit.5 An advantage of this test is that we can

directly compare the relative explanatory power of the accounting variables to determine an

ordering or ranking of their explanatory power. We then can observe whether this ranking

differs in the crisis period. Our expectations on the relative relevance of the accounting

variables are consistent with our discussion above. During the crisis period, we expect that the

R2 of book values will be higher than both the earnings and cash flows models. We also expect

that cash flows will have greater explanatory power than earnings during the crisis period.

V. SAMPLE SELECTION AND RESULTS

Sample Selection and Description

The sample consists of all Mexican firms traded on the Mexican Stock Exchange (Bolsa)

during the period 1992-1997 for which we were able to obtain stock prices, book values,

earnings, and cash flows for all six years. Since our research design compares two time periods,

we require firms to be in the sample for the full six-year period in order to control for changes in

industry composition and/or the stage of development, which could potentially influence the

results. Financial statement and price data are collected from Economatica, a commercial

database of Latin American companies. Where necessary, we also supplement the data with

5 Estimating separate equations of the relation between price and book values, earnings and cash flows potentially
leads to model misspecification resulting from correlated omitted variables. However, extant research has used the
same models to investigate the set of firms or conditions under which equity book value or earnings would be
assigned a relatively higher multiple or would explain a relatively higher proportion of the variation in market value
of equity (e.g., Burgstahler and Dichev 1997; Collins et al. 1997; Barth et al. 1998).

17
annual financial data and statistics published by the Bolsa. Our full sample includes 31

December 31 fiscal year end firms with data available throughout the entire sample period.6

Table 1 describes the industry distribution of our sample firms. Of the 31 sample firms,

the largest number (seven) belongs to the holding company sector and represents 22.6% of the

sample followed by commerce with five companies (16.1%). The rest are in a variety of sectors

(including beverage, cement, construction, telecommunications, steel, hotel and tourism, mining,

and paper). While the sample is small in absolute terms, it represents approximately 58% (28%)

of the market capitalization of (companies traded on) the Mexican stock exchange in 1992 and

22% (22%) of market capitalization (companies traded) in 1997.

[Insert Table 1 here]

Table 2 presents descriptive statistics for the main regression variables and components

of book values and earnings. To facilitate comparison across the six years when inflation rates

varied from 7% to 52%, we inflation-adjust all variables to December 31, 1997. During the

crisis the median value of earnings significantly decreased, driven by the significant increase in

the incidence of companies reporting negative earnings. The percentage of sample firms that

reported negative earnings during (outside of) the crisis period is 24.6% (8.1%). Paired t-tests

and Wilcoxon signed rank tests (not reported) indicate that the mean and median crisis period

percentages are significantly higher than the periods before and after the crisis. Mean and

median inflation-adjusted market values, book values and cash flows do not significantly differ

during and outside of the crisis.

6 We restrict the sample to firms for which all of the necessary data are available in all of the sample years. We also
estimate the analyses with the largest number of firms available in each year (up to 45 in 1997) and find that the
results are qualitatively the same.

18
 When we examine components of book values and earnings, we find that the mean

(median) integral financing costs significantly increased during the crisis, driven by the

significant increase in foreign exchange losses. From the descriptive statistics we see that the

increased prevalence of negative earnings during the crisis can be primarily explained by high

foreign exchanges losses.

The median of both the revaluation reserve and changes in the revaluation reserve are

significantly higher during the crisis suggesting that companies increased the reported values of

tangible assets during the crisis. One explanation for the increase in the reported value of non-

monetary assets is the dollarization of the assets. As the exchange rate of the peso increases, the

current cost of the dollarized assets increases. Another explanation for the increase during the

crisis is that the demand (and value) of non-monetary assets increases as companies move into

non-monetary assets to avoid losses on monetary assets during inflationary periods.

[Insert Table 2 here]

Primary Results

Table 3 contains regression results relating to our tests of the roles of book value,

earnings and cash flows during the financial crisis.7 Panel A presents evidence relating to the

coefficient estimates and incremental explanatory power for book values and earnings. We find

that the coefficient on book value is significant in both periods. The coefficient on earnings is

significant outside of the financial crisis period but earnings is not significantly different from

zero in the crisis period, implying that book values capture information relating to unrecognized

7 We also estimate annual regressions and take the weighted average of coefficients and White-t statistics to
compare the crisis and non-crisis period. This approach eliminates potential problems with cross-sectional
correlation associated with the use of pooled data. However, we are unable to statistically test for differences
between our two periods. The results appear consistent with those presented in table 3 with one exception. The

19
net assets in this period. When we test for differences in coefficients between crisis and non-

crisis periods, we find that the coefficient on book value is not significantly different but that on

earnings is significantly lower during the crisis period. Regarding the examination of the

incremental explanatory power, our results indicate that the incremental explanatory power of

book values increases during the crisis and that of earnings decreases.

Table 3, panel B, which controls for the presence of negative earnings, sheds light on the

decreased coefficient and incremental relevance of earnings. Results, after controlling for

negative earnings, show that book values and earnings are significant in both periods.

Additionally, the coefficient on earnings is now not significantly different between time periods.

We present the tests including negative earnings separately to compare and reconcile our results

to related studies. Both Graham et al. (2000) and Ho et al. (2001) find that the relevance of

earnings drops during the Korean currency crisis even after controlling for negative earnings.

When we do not control for negative earnings we find that the coefficient of earnings declines

during the crisis period. However, when we do control for negative earnings, the coefficient on

earnings remains significant during the crisis period. Additionally, unlike the findings in the

Asian crisis papers, the coefficient on earnings during the crisis period is not significantly

different than the coefficient on earnings in the non-crisis period, suggesting that earnings do not

lose relevance during the crisis after taking negative earnings into account.

Table 3, panel C, divides earnings into cash flows from operations and accruals. Results

indicate that neither cash flows nor accruals are significant during the crisis period, implying that

cash flows do not contribute to the explanatory power of book values during this period.

coefficient on earnings during the crisis is significant with a p-value of less than 0.05. However, the magnitude of
the coefficient on earnings during the crisis is substantially lower less than one-third of that outside of the crisis.

20
Additionally, the coefficient on cash flows is significantly lower during the crisis period.

Interestingly, Ho et al. (2001) find that the valuation of cash flows during the Asian crisis

increases relative to earnings. The different findings in Mexico could be attributable to the use

of replacement cost and price level accounting.

To summarize the results presented in table 3, book values retain their significance and

explanatory power during the crisis while earnings do not. The coefficient on book values does

not significantly change during the crisis period. Additionally, the incremental explanatory

power of book values is consistently high during and outside of the crisis. The coefficients on

and the explanatory power of earnings decline during the crisis period. The decline, however, is

attributable to the presence of negative earnings. The coefficient on and the explanatory power

of cash flows also decline during the crisis period.8

[Insert Table 3 here]

Table 4, panel A, which presents regression results relating to our tests of the individual

roles of book value, earnings and cash flows during the financial crisis, supports and

complements the results in table 3. We find that the coefficient on book value does not

significantly differ during the crisis period while the total explanatory power of book values

increases. The coefficient on earnings and the explanatory power of earnings are lower during

the crisis period. However, after controlling for negative earnings, the coefficient on earnings

increases implying those firms that have positive earnings during the crisis period have higher

unrecognized net assets. The coefficients on cash flows and accruals are significantly lower

during the crisis period as is their overall explanatory power. Interestingly, during the financial

21
crisis the coefficient on cash flows was not significant in the presence of book values while it is

significant when examined separately implying that book values capture the information about

unrecognized net assets in cash flows during the crisis.

Table 4, panel B, compares the relative explanatory power of book value, earnings and

cash flows during and outside of the financial crisis. During and outside of the crisis, book

values retain their greater explanatory power relative to earnings and cash flows. During the

crisis the explanatory power of book values relative to earnings and negative earnings increases.

When we examine the explanatory power of earnings, we find that during the crisis it decreases

relative to both earnings and negative earnings and cash flows suggesting that negative earnings

reduces the explanatory power of earnings relative to other variables. Increasingly outside of the

crisis, only book values have greater explanatory power than other variables.

[Insert Table 4 here]

Sensitivity Analyses for Mexico

In this section, we perform additional tests to explore specific features of Mexican

accounting that are designed to capture the macroeconomic effects of changing prices on both

net monetary assets and non-monetary assets. We examine whether specific components of

Mexican financial statements that capture these effects are valued similarly in the crisis and non-

crisis periods. Our tests are motivated by Ohlson and Penman (1992) who indicate that summary

earnings and book values are insufficient determinants of market values because of differential

measurement errors in line items. In the absence of measurement error, the disaggregation of

earnings into line items does not enhance the explanatory power of regressions (with returns as a

8 When we use the market value four months after year-end as the dependent variable, results are robust with one
exception. The coefficient on cash flows during the crisis period remains insignificantly different than zero;

22
dependent variable). If there is incremental explanatory power in the disaggregated model, then

the independent variables are measured with error. So, if the valuation coefficients on the

earnings line items are approximately the same and have the correct signs, then the model can be

reduced to aggregate earnings (i.e., there is no value added by the disaggregation). Otherwise,

the disaggregated model is more relevant. An alternative but consistent explanation for

differences in the valuation coefficients between earnings line items is that they vary with the

persistence of the components and their ability to predict future abnormal earnings (Barth,

Beaver, and Landsman, 1999; Ohlson, 1999).

In our tests, we disaggregate both earnings and book values to examine specific

components related to the macroeconomic effects of the currency devaluation.9 The specific

components that we examine related to the macroeconomic effects of the currency devaluation

are monetary gains/losses, exchange gains/losses, foreign revenues, foreign currency-

denominated debt and asset revaluations. We discuss each of these further below.

To assess the relevance of specific earnings components we believe are directly affected

by the devaluation, we first disaggregate earnings to focus on monetary gains/losses, exchange

gains/losses and foreign revenues. The monetary gain/loss is realized from holding net monetary

assets or liabilities and reflects the impact of inflation on monetary assets and liabilities. Foreign

exchange gains and losses result from the impact of changes in exchange rates on assets and

liabilities denominated in currencies other than pesos. The magnitude of both of these

components is expected to vary with the macroeconomic conditions and firm-specific factors.

While we expect the valuation coefficients on the monetary gains/losses and exchange

however, it is no longer significantly different than the coefficient on cash flows outside of the crisis period.
9 We treat price levels as extreme return intervals and regress them on earnings and book values.

23
gains/losses to be positive, we do not have an expectation regarding changes in the valuation

during the crisis. If the valuation coefficient is lower (higher) during the crisis, we can interpret

this as the components being less (more) persistent due to more (less) uncertainty about future

events or as having less (more) measurement error during the crisis.

To test whether these components are valued differently during the crisis, we estimate a

model that includes earnings exclusive of monetary gains/losses and exchange gains/losses,

monetary gains/losses, and exchange gains/losses. We include interactive terms for each

variable during the crisis and an interactive variable for negative net income. Results are

reported in table 5, panel A. The results for earnings are similar to those presented in table 4.

The coefficient is positive, significant and higher during the crisis (in the presence of negative

net income). The coefficients on monetary gains/losses and exchange gains/losses are also

positive and significant. The coefficients on the interactive variables for both monetary

gains/losses and exchange gains/losses are not significantly different from zero during the crisis

period suggesting that an economic crisis does not change the markets valuation of these line

items.

We continue to investigate the influence of foreign transactions during the crisis period

by examining the valuation of foreign revenues.10 Thomas (2000) provides empirical evidence

that the market understates foreign earnings persistence for a sample of multinational U.S. firms.

Therefore, we test whether foreign revenues, which may serve as a hedge during a domestic

crisis, are valued more highly during the crisis period. We expect that the valuation coefficient

on domestic and foreign revenues will be positive and that on net income less revenues

10Due to high and significant correlation between exchange gains/losses and foreign revenues, we cannot include
both in the same regression. Therefore, we estimate separate regressions relating to foreign revenues.

24
(representing primarily expenses) will be negative. We have no predictions on interactive

variables other than that on foreign revenues.

We estimate a model including domestic revenues, foreign revenues, and net income

exclusive of domestic and foreign revenues. We add interactive terms for the devaluation period

and an interactive variable for negative net income. Results are presented in table 5, panel B.

As expected, the coefficients on the foreign and domestic revenue are positive and significant

and the coefficient on the expense variable is negative and significant. However, we find that

the coefficient on foreign revenues during the devaluation period is positive but not significantly

different from zero while the coefficient on domestic revenues during the crisis period is

negative but not significant. These results suggest that the market values foreign and domestic

revenues similarly during and outside of times of domestic financial distress.

Our book value regression examines the valuation of current cost accounting asset

revaluations and foreign currency denominated debt. In their sample of U.S. firms, Barth,

Beaver and Landsman (1998) find that the valuation of book values increases for firms in

financial distress as book values approximate liquidation values. We find no change in the

valuation of book values during the currency crisis. A possible explanation is the use of current

cost accounting. If the market believes that the adjustments to current cost reliably state the

reported value of the assets, then the market valuation will not differ.

To further explore the effect of the change in the exchange rate we investigate the

valuation of firms foreign currency denominated debt. We expect foreign currency

denominated debt, like any firm liability, to be negatively related to market value. In Mexico,

foreign currency denominated debt is reported in pesos using the exchange rate at the reporting

date. As Graham et al. (2000) discuss, the value of the foreign currency denominated debt

25
ultimately depends on exchange rates at actual payment dates. So, the more volatile the

exchange rates the less likely current accounting will correspond to future cash outlays. If there

is uncertainty about the persistence of the exchange rate, foreign currency denominated debt may

be valued differently during the financial crisis. We separate long-term and short-term foreign

currency denominated debt because short-term debt will be less influenced by uncertainty in the

exchange rate and the firm may benefit by paying off the short-term debt with the devalued peso.

We estimate a regression including book value exclusive of foreign debt and the asset

revaluation reserve, long-term foreign debt, short-term foreign debt and the asset revaluation

reserve. We add interactive terms for the devaluation period. The results of the regression,

presented in table 5, panel C, indicate that the valuation coefficient on the revaluation reserve is

lower during the devaluation period. However, unreported F-tests indicate that the revaluation

reserve coefficient is not significantly different than that on book value both during and outside

of the crisis. Therefore, we do not interpret this evidence as current cost accounting being less

relevant during the crisis. Rather, the revaluation reserve is valued similar to book values.11

Results also indicate that both long-term and short-term foreign currency denominated debt are

negatively and significantly associated with market values, as expected. The incremental

valuation coefficient on short-term foreign currency denominated debt during the crisis is

significant and positive suggesting, on average, companies will benefit from paying off debt with

a currency that has a lower value. In contrast, the incremental valuation coefficient on long-term

foreign currency denominated debt is positive but not significant. An implication is that the

11 We also estimate an earnings model including the change in the asset revaluation reserve. It is not significantly
related to market value in either the crisis or non-crisis period.

26
current exchange rate will not persist into the future, which is consistent with our finding that

exchange gains and losses are not differently valued during the crisis period.

[Insert Table 5 here]

VI. SUMMARY AND CONCLUSIONS

Our study investigates the relation between stock prices and fundamental accounting

information in the emerging Mexican market in the period surrounding the 1994 peso

devaluation. Evidence in the U.S. suggests that as firms face financial distress earnings will lose

their value relevance while the value relevance of book value increases (Barth et al. 1998). We

find that the valuation of book value does not significantly change while its incremental and

relative explanatory power increases during the crisis period but both the valuation and

explanatory power of earnings decline during the crisis period. The decline in the value

relevance of earnings and its explanatory power, however, is attributable to the presence of

negative earnings.

Financial statements in Mexico are prepared using general price level and current cost

adjustments. As a result of these practices, earnings contain adjustments for the effects of

monetary gains and losses and book values include revaluation reserves for fixed assets. Overall

our examination of the relation between Mexican accounting information and stock prices

indicates that the value relevance of accounting information in Mexico, measured by the

valuation coefficient from price regressions, does not decrease during times of economic crisis.

It appears that the value relevance of Mexican accounting information, which includes general

price level and replacement cost adjustments, is robust to an economy-wide economic crisis.

27
Therefore, the Mexican accounting system may serve as a model for the financial reporting

changes that have been proposed in the U.S.

28
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31
 TABLE 1
Industry Distribution of the Sample Firms

Sector Name* Firms Percent

Beverage 3 9.7%
Cement 3 9.7%
Commerce 5 16.1%
Construction 1 3.2%
Food 3 9.7%
Holding Company 7 22.6%
Mining 1 3.2%
Paper Pulp 1 3.2%
Steel Plant 1 3.2%
Telecommunications 2 6.5%
Tourism & Hotel 2 6.5%
Various 2 6.5%
Total 31 100.0%

32
 TABLE 2
Descriptive Statisticsa
(In millions of pesos inflation adjusted to December 31, 1997)

Crisis Before and After Crisis P-Values of

(1994-1995) (1992-1993 and 1996-1997) Tests of
Variable Mean Std Dev Median Mean Std Dev Median Mean Median
Market Value 12,400 21,257 5,100 15,076 25,657 5,938 0.483 0.653
Book Value of Equity 7,255 12,578 3,572 7,100 12,833 3,089 0.978 0.798
Earnings 564 1,841 161 1,052 2,452 342 0.172 0.004
Number of Observations with Negative Earnings 0.246 0.434 0 0.081 0.274 0 0.002 0.002
Cash Flow from Operations 1,118 3,143 372 1,487 3,649 505 0.500 0.174
Accruals -553 1.527 -187 -434 2,049 -864 0.690 0.166
Sales - domestic 5,598 6,346 3,380 6,513 8,464 3,590 0.458 0.905
Sales - foreign 1,307 2,188 440 1,470 2,898 300 0.700 0.837
Operating Income 1,169 2,519 433 1,341 3,041 475 0.704 0.638
Integral Financing Costs -382 1,096 -168 112 507 19 0.000 0.000
Net Interest Expense -265 1,053 -62 -262 843 -51 0.981 0.821
Monetary Gain/Loss 676 1,698 85 432 1,068 56 0.235 0.995
Exchange Gain/Loss -927 1,562 -299 -151 437 -8 0.000 0.000
Revaluation Reserve^ 2,518 16,943 0 -2,292 20,452 -820 0.146 0.000
Change in Revaluation Reserve^ -1,817 11,561 1 -3,253 24,018 -271 0.678 0.001
Foreign Currency Liabilities - Short-term 1,791 2,680 766 1,298 2,201 466 0.186 0.106
Foreign Currency Liabilities - Long-term 2,398 3,937 1,075 2,462 4,790 762 0.929 0.405
Local Currency Liabilities 1,951 2,488 787 2,088 3,060 866 0.762 0.731

33
a
There are 31 firms in the sample. The sample includes all firms in the Economatica database in 1993 for which all of the necessary data are available for all
six-sample years. All firms in Mexico are required to use December 31 fiscal year ends.
^ Due to data limitations, the change in the asset revaluation reserve is not available for 1992. Therefore, both the revaluation reserve and change in the
revaluation reserve are reported for the five years 1993 through 1997 only.

34
 Table 3
Results from Tests of the Valuations and Incremental Relevance of Book Values, Earnings and Cash Flow from Operations

Crisis Before and After Crisis Difference

Panel A: Book Value and Earnings Regression:
Coefficient
Regression results Coefficient White t-stat Coefficient White t-stat Difference
Intercept 7.679 5.456 *** 8.886 6.624 *** -1.207
Book Value 0.976 12.203 *** 0.882 9.850 *** 0.094
Earnings 1.012 1.616 2.618 4.805 *** -1.606 *

Percent of Percent of Difference in Difference in

Incremental R-squared R squared Total R squared Total R squared Percent of Total
Book Value and Earnings total 0.832 0.766 0.065

Book Value incremental 0.673 80.9% 0.216 28.2% 0.457 52.7%

Earnings incremental 0.017 2.0% 0.075 9.8% -0.058 -7.7%
Common 0.141 16.9% 0.475 62.0% -0.334 -45.1%

Panel B: Book Value, Earnings and Negative Earnings Regression:

Coefficient
Regression results Coefficient White t-stat Coefficient White t-stat Difference
Intercept 6.951 5.029 *** 8.186 6.072 *** -1.235
Book Value 0.840 6.510 *** 0.775 7.572 *** 0.066
Earnings 2.945 2.315 *** 3.523 4.153 *** -0.578
Negative Earnings -2.929 -1.444 -2.801 -2.703 *** -0.128

Percent of Percent of Difference in Difference in

Incremental R squared R squared Total R squared Total R squared Percent of Total
Book Value, Earnings and
Negative Earnings total 0.843 0.781 0.062

Book Value incremental 0.260 30.84% 0.243 31.11% 0.017 -0.3%

Earnings incremental 0.022 2.61% 0.082 10.50% -0.060 -7.9%
Negative Earnings incremental 0.011 1.30% 0.014 1.79% -0.003 -0.5%
Common 0.550 65.24% 0.442 56.59% 0.108 8.6%

35
 Table 3 (continued)
Results from Tests of the Valuations and Incremental Relevance of Book Values, Earnings and Cash Flow from Operations

Crisis Before and After Crisis Difference

Panel C: Book Value, Cash Flow from Operations and Accruals Regression:

Regression results Coefficient White t-stat Coefficient White t-stat Difference

Intercept 7.649 5.456 *** 9.055 6.656 *** -1.406
Book Value 1.004 10.773 *** 0.906 9.981 *** 0.098
Cash Flow from Operations 0.957 1.549 2.399 4.299 *** -1.443 *
Accruals 1.223 1.595 2.732 4.260 *** -1.509

Percent of Percent of Difference in R Difference in

Incremental R squared R squared Total R squared Total squared Percent of Total
Book Value, Cash Flow from
Operations and Accruals total 0.832 0.768 0.065

Book Value incremental 0.394 47.4% 0.204 26.6% 0.190 20.8%

Cash Flow from Operations
incremental 0.014 1.7% 0.045 5.9% -0.031 -4.2%
Accruals Incremental 0.018 2.2% 0.076 9.9% -0.059 -7.7%
Common 0.406 48.8% 0.442 57.6% -0.037 -8.8%

Notes:
***, **, * indicate significance at the 0.01 level or better, the 0.05 level; and the 0.10 level, respectively, in two-tailed tests.

36
 Table 4
Results from Tests of the Valuations and Relative Relevance of Book Values, Earnings and Cash Flow from Operations

Crisis Before and After Crisis Difference

Panel A: Regression results

Coefficient White t-stat Coefficient White t-stat Difference

Book Value
Intercept 7.039 4.838 *** 8.196 4.838 *** -1.157
Book Value 1.027 12.500 *** 1.214 10.240 *** -0.187
R squared 0.814 0.691 0.123

Earnings
Intercept 25.355 8.772 *** 17.949 7.635 *** 7.406
Earnings 3.033 2.155 ** 5.456 6.042 *** -2.423 **
R squared 0.158 0.550 -0.392

Earnings and Negative Earnings

Intercept 11.558 4.700 *** 13.678 6.553 *** -2.119
Earnings 10.185 8.625 *** 6.783 6.690 *** 3.403 ***
Negative Earnings -12.681 -8.448 *** -6.641 -5.100 *** -6.041 ***
R squared 0.617 0.645 -0.028

Cash Flow from Operations and Accruals

Intercept 18.404 6.052 *** 16.702 6.685 *** 1.703
Cash Flow from Operations 3.003 3.044 *** 5.886 6.394 *** -2.883 ***
Accruals -0.923 -0.819 4.881 4.269 *** -5.803 ***
R squared 0.438 0.564 -0.126

Notes:
***, **, * indicate significance at the 0.01 level or better, the 0.05 level; and the 0.10 level, respectively, in two-tailed tests.

37
 Table 4 (continued)
Results from Tests of the Valuations and Relative Relevance of Book Values, Earnings and Cash Flow from Operations

Panel B: Results of relative relevance Crisis Before and After Crisis

Book Value v. Earnings BV > X *** BV > X *

Book Value v. Earnings and Negative Earnings BV > X + Neg X * BV = X + Neg X
Book Value v. Cash Flow from Operations and Accruals BV > CFO + ACCR *** BV > CFO + ACCR *

Earnings v. Earnings and Negative Earnings X < X + Neg X ** X = X + Neg X

Earnings v. Cash Flow from Operations and Accruals X < CFO + ACCR ** X = CFO + ACCR

Earnings and Negative Earnings v. Cash Flow from X + Neg X = CFO + ACCR X + Neg X = CFO + ACCR
Operations and Accruals

Variable definitions: BV is book value per share of company i at time t; X is earnings per share of company i over the period ending at time t; CFO cash flow
from operations per share of company i over the period ending at time t; ACCR are the accruals per share of company i over the period ending at time t; NEG is a
dummy variable taking the value of one if the variable (X) is negative.

Notes:
***, **, * indicate significance at the 0.01 level or better, the 0.05 level; and the 0.10 level, respectively, in two-tailed tests. For nested regressions significance
is based on tests of incremental R-squareds. For non-nested regressions, significance is based on Vuong tests.

38
 Table 5
Results from Tests of the Components of Earnings and Book Values

Panel A: Earnings Components: Monetary Gains/Losses and Exchange Rate Gains/Losses

X-MGL-
X-MGL- ExGL MGL ExGL
INT DDEV ExGL *DDEV MGL *DDEV ExGL *DDEV X*NEG Adj. R2
Coefficient 12.261 -1.151 8.534 2.261 5.057 0.846 7.955 -1.069 -10.455 0.721
White t-stat 7.772 *** -0.488 12.941 *** 2.258 ** 4.118 *** 0.417 5.484 *** -0.653 -7.441 ***

Panel B: Earnings Components: Domestic and Foreign Revenues

DomREV ForREV*
INT DDEV DomREV *DDEV ForREV DDEV X-REV X*NEG Adj. R2
Coefficient 5.734 2.428 5.938 -0.200 5.109 0.538 -5.183 -5.008 0.751
White t-stat 3.827 *** 1.004 8.616 *** -0.772 6.549 *** 1.557 -7.066 *** -4.297 ***

Panel C: Book Value Components

BV- BV- LT ST
ForDebt- ForDebt- ForDebti ST ForDebti RR
INT DDEV RR RR*DDEV LT ForDebt *DDEV ForDebt *DDEV RR *DDEV Ad.j R2
Coefficient 8.275 -0.658 1.479 -0.420 -1.559 0.544 -2.408 1.114 1.470 -0.420 0.759
White t-stat 5.349 *** -0.307 10.908 *** -2.144 ** -7.231 *** 1.602 -4.506 *** 1.771 * 10.796 *** -2.140 **

Variable definitions: BV is book value per share of company i at time t; X is earnings per share of company i over the period ending at time t; MGL is the
monetary gain/loss per share of company i over the period ending at time t; ExGL is the foreign currency gain/loss per share of company i over the period ending
at time t; DomREV is the domestic revenues per share of company i over the period ending at time t; ForREV is the foreign revenues per share of company i over
the period ending at time t; ForREV is the foreign revenues per share of company i over the period ending at time t; REV is the total revenues per share of
company i over the period ending at time t; ForDebt is foreign currency denominated debt per share of company i at time t; LT is long-term; ST is short-term; RR
is revaluation reserve per share of company i at time t; DDEV is a dummy variable taking the value of one in the years affected by the currency devaluation:
1994 and 1995; NEG is a dummy variable taking the value of one if the variable (X) is negative.

Notes:
***, **, * indicate significance at the 0.01 level or better, the 0.05 level; and the 0.10 level, respectively, in two-tailed tests.

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