Analysis of Business

The Value-Relevance of Accounting Figures in the International Oil and Gas Industry – Cash flows or Accruals?

by Bård Misund1,3, Petter Osmundsen1,2 and Frank Asche1,2 1 University of Stavanger 2 SNF

contact details: Bård Misund Research Fellow Department of Industrial Economics, University of Stavanger N-4036 Stavanger, Norway phone: +47 51 83 19 08 fax: 51 83 17 54 email: bard.misund@uis.no

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Abstract Analysts often rely on a given set of accounting figures for evaluating the financial performance and valuation of oil and gas companies. However, the relative importance of these measures in the equity valuation process is unclear. The aim of this study is to determine the relative value-relevance of accounting figures using regression analysis of market and accounting data for 15 of the largest international oil and gas companies in the period 1990-2003. The results show that accounting figures calculated before the expensing of depreciation are more value-relevant than net figures. This indicates that investors have more confidence in profits before depreciation and in cash flows, than they have in net income.

1. Introduction Analysts covering the petroleum industry often focus on various accounting figures in their analyses of the financial performance and valuation of oil and gas exploration companies. Typically, they compare earnings before interest, taxes, depreciation and amortization (EBITDA), net operating profit after tax (NOPAT), net income (NI) and debt-adjusted cash flow (DACF). These accounting figures have several applications; for example, they are used in the numerator in performance measures, such as return on equity (ROE) or return on capital employed, and in the denominator in valuation multiples, such as the price-to-earnings ratio (P/E). Presumably, these accounting measures are chosen because they are thought to be relevant to performance measurement, and especially to valuation. However, there has been little academic research to...