EVC signed error

Table 4.1 reports means and medians o f the EVC signed errors from omission o f dirty surplus flows for each class o f dirty surplus flow and for each country. Panel A reports signed errors for the three-year measurement interval; panel B reports those for the eight-year measurement interval. The errors are scaled both by beginning-of-interval market value and by the absolute value o f the correct (clean surplus) measure o f EVC as defined in expressions (4.8) and (4.9). The first scaling procedure gives the error in measurement o f the excess rate o f return on the beginning-of-interval market value; the second gives the proportionate error in the EVC measure. Each panel reports, for each country and for each dirty surplus EVC measure, the result o f a non-parametric signed-rank test o f the null hypothesis that the distribution o f signed errors is centred on zero. Each panel also reports test statistics for non-parametric Kruskal-W allis tests o f the null hypothesis that the average rank o f signed errors across countries is equal. This test is performed for the seven classes o f dirty surplus flows both for all four countries together, and for each paired combination o f countries.

For the three-year interval, table 4.1, panel A shows that the null hypothesis that the distribution o f errors is centred on zero is rejected for all dirty surplus flows in three cases (Germany, U.K., U.S.) for both the market value-scaled and EVC-scaled errors. For goodwill, it is rejected in three cases (France, Germany, U.K.) for the market value-scaled errors and in two cases (Germany and U.K.) for the EVC-scaled errors. For the merger-related item, it is rejected in one case (U.S.) for both the market value-scaled and EVC-scaled errors. For goodwill inclusive o f the merger-related item, it is rejected in all four cases for the market value-scaled errors and in three cases (Germany, U.K. and U.S.) for the EVC-scaled errors. For asset revaluations,

prior-year adjustments and 'other dirty surplus flows', it is never rejected, which indicates that the bias introduced in the EVC measure by disregarding dirty surplus flows is mostly attributed to goodwill-related items. The relevance o f the goodwill items is confirmed by results o f the non-parametric Kruskal-W allis tests o f the null hypothesis o f the equality o f mean rank in signed errors across countries. For both the market value-scaled and EVC-scaled errors, the null hypothesis is rejected only for goodwill and goodwill inclusive o f the merger-related items.

The results o f the tests o f equality o f mean rank across pairs o f countries are similar for both scaling methods. Results indicate that there are more cases o f significant differences in the signed errors for the goodwill category. Significant differences occur for the pairs France/Germany, France/U.K., France/U.S., Germany/U.S., U.K./U.S (for market value scaled-errors) and France/Germany, France/U.K., Germany/U.S., U.K./U.S. (for EVC scaled-errors). The next most important category regarding the number o f pairs o f countries for which the null hypothesis is rejected is the goodwill inclusive o f the merger-related item. The hypothesis is rejected four times (France/Germany, France/U.K., Germany/U.S., U.K./U.S.) for both scaling methods. Significant differences arise also in the category ‘all dirty surplus flows’ for the pairs France/Germany, France/U.K, for both scaling methods. No rejections arise in the case o f asset revaluations, prior-year adjustments or other dirty surplus flows.

For the eight-year horizon, reported in panel B o f table 4.1, the null hypothesis that the distribution o f the signed errors is centred on zero is rejected twice (Germany, U.S.) when all dirty flows are omitted, regardless o f the scaling method. For goodwill, it is rejected in two cases (Germany, U.K.) for both scaling methods. Rejections for the same two countries arise for the goodwill inclusive o f the merger-related item

category (for both market-scaled and EVC-scaled errors). However, this result seems to be attributable entirely to the goodwill item, as I find no rejections when considering the merger-related item separately. For the other classes o f dirty surplus flows, there are few rejections. For asset revaluations, rejection occurs once for the U.K. in the case o f the EVC-scaled errors. For prior-year adjustments it is never rejected. For 'other dirty surplus flows', it is rejected once (U.K.) for both scaling methods.

Similar to the three-year interval, the null hypothesis o f equality o f mean rank in errors across all four countries is rejected for the goodwill items. For both scaling methods, is rejected for goodwill, the merger-related item and goodwill inclusive o f the merger-related item, but not in any other case. Regarding differences in the signed errors across pairs o f countries, the results o f the Kruskal-Wallis tests reveal that rejections o f the null hypothesis are identical regardless o f whether the errors are scaled by market value or EVC. Rejections occur for goodwill in four cases (France/Germany, France/U.K., Germany/U.S. and U.K./U.S.), for the merger-related item in two cases (France/U.S. and Germany/U.S.), for goodwill inclusive o f the merger-related item in four cases (France/Germany, France/U.K., Germany/U.S. and U.K./U.S.), and finally for 'other dirty surplus flows' in the case o f Germany/U.K.

The overall impression conveyed by table 4.1 is that bias in the measures of abnormal performance caused by omission o f dirty surplus flows, and cross-country variation therein, arise largely as a result o f the merger item (which is treated here similarly to a goodwill write-off) and goodwill. The influence o f asset revaluations, prior-year adjustments and 'other dirty surplus flows' in creating such effects is relatively small. This conclusion is not surprising given the findings reported in the previous chapter that goodwill and goodwill related to merger accounting are the main

contributors to dirty surplus accounting in the countries and period studied. Disregarding the goodwill-related dirty surplus flows from performance measures based on abnormal residual income results in overestimates o f the measures (as goodwill has a negative sign thus reducing net income). This positive bias can have economic consequences as it may overstate business performance, m anagers’ bonuses or any other assessment based on EVC-type o f measures. It is worthwhile mentioning again that the problem posed by the goodwill-related items in this context is being removed as regulators restrict the use o f merger (pooling-of-interests) accounting and goodwill write-offs and therefore the impact o f disregarding dirty surplus flows in creating bias in performance measurement may be limited to the period analysed.40