{"id":2238,"date":"2024-06-23T11:24:25","date_gmt":"2024-06-23T15:24:25","guid":{"rendered":"https:\/\/www.kaichen.work\/?p=2238"},"modified":"2024-06-23T16:53:15","modified_gmt":"2024-06-23T20:53:15","slug":"how-to-calculate-book-to-market-exactly","status":"publish","type":"post","link":"https:\/\/www.kaichen.work\/?p=2238","title":{"rendered":"Unlocking the black box: how to calculate book-to-market?"},"content":{"rendered":"

The book-to-market ratio (BM<\/code>) is one of the most frequently calculated variables in accounting research and is usually used as a control variable in regressions. However, how to calculate it is a question I often asked when I started my PhD, as nobody defined it clearly in their papers. Should I use CEQ<\/code> or SEQ<\/code>, assets minus liabilities, or something else? This question becomes even more confusing when I realize that finance researchers often define the book value of equity differently from accounting researchers.<\/p>\n

A related question is how to verify the basic accounting equation (A = L + E) using Compustat Annual (FUNDA) or Quarterly (FUNDQ) data? To answer this question, I checked the Compustat Manuals – Balancing Models – North American Company Data<\/a>:<\/p>\n

\"\"<\/a><\/p>\n

Therefore, the basic accounting equation is reflected in the following relationship:<\/p>\n

AT<\/code> = LSE<\/code><\/p>\n

Or AT<\/code> = LT<\/code> + MIB<\/code> + TEQ<\/code><\/p>\n

The first equation can be verified using FUNDA data. However, the second equation holds true for only 42% of observations. Further investigation indicates that prior to FASB 160, LSE<\/code> = LT<\/code> + MIB<\/code> + SEQ<\/code>, while after FASB 160, LSE<\/code> = LT<\/code> + MIB<\/code> + TEQ<\/code>. That’s why the above second equation won’t hold true prior to FASB 160.<\/p>\n

Returning to the initial question, BM<\/code> = Book Value of Equity (BVE<\/code>) \/ Market Value of Equity (MVE<\/code>). When calculating MVE<\/code>, we appear only able to use MVE<\/code> = csho<\/code> \u00d7 prcc_f<\/code>, where csho<\/code> is the number of common shares outstanding, and prcc_f<\/code> is the share price at the fiscal year-end. Therefore, MV<\/code> will be the market value of common shares. To match this, it seems appropriate to define BVE<\/code> as ceq<\/code>(also common shares), and thus BM<\/code> = ceq<\/code> \/ (csho<\/code> \u00d7 prcc_f<\/code>).<\/p>\n

In contrast, in the sample code provided by WRDS to replicate Fama-Frech’s three factors, as well as in the Financial Ratios macro provided by WRDS, BVE<\/code> = seq<\/code> + txditc<\/code> – pstk<\/code>. The definitions of these variables can be found in the above figure. Although seq<\/code> – pstk<\/code> = ceq<\/code>, I have no clue why txditc<\/code> should be added. Perhaps finance researchers can shed light on this.<\/p>\n","protected":false},"excerpt":{"rendered":"

The book-to-market ratio (BM) is one of the most frequently calculated variables in accounting research and is usually used as a control variable in regressions. However, how to calculate it is a question I often asked when I started my … Continue reading →<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[11],"tags":[16],"_links":{"self":[{"href":"https:\/\/www.kaichen.work\/index.php?rest_route=\/wp\/v2\/posts\/2238"}],"collection":[{"href":"https:\/\/www.kaichen.work\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.kaichen.work\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.kaichen.work\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.kaichen.work\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=2238"}],"version-history":[{"count":9,"href":"https:\/\/www.kaichen.work\/index.php?rest_route=\/wp\/v2\/posts\/2238\/revisions"}],"predecessor-version":[{"id":2252,"href":"https:\/\/www.kaichen.work\/index.php?rest_route=\/wp\/v2\/posts\/2238\/revisions\/2252"}],"wp:attachment":[{"href":"https:\/\/www.kaichen.work\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=2238"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.kaichen.work\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=2238"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.kaichen.work\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=2238"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}