5 ESTIMATION AND EMPIRICAL RESULTS

5.1 The Estimation Procedure

If empirical data is available on yearly capital expenditures in different classes, as well as on the average life-spans Nk of fixed assets in the various classes. Formula (18) is applied in estimating profitability. If either data is unobtainable, (11) is used instead. In that case the annual capital expenditures of the firm are calculated as a lumpsum from the financial statements of the business enterprise considered, and the life-span N is estimated e.g. as an industry average of all fixed assets. Such data is available._5 The categories of fixed assets used in the application to be presented shortly are 1) Construction in process, 2) Land, water, bonds and shares, 3) Buildings, and 4-5) Two classes of machinery and equipment.

Growth-rate g has normally been estimated from the empirical time-series of funds from operations in applications of the model._6 The seemingly unrelated regression technique can be used in troublesome cases._7

The components of the long-run financing policy are computed as the weighted sum of the yearly observations of the empirical counterparts of the items of the funds-flow statement. These empirical counterparts are easily computed from the annual income statements and the balance sheets of a business enterprise. Details of these computations are omitted here._8 The estimated growth factors 1/(1+g)^(n-t) are used as the weights. (For example, if g^ = 0.10, the second set of observations is divided by 1.10, the third by 1.21, etc.) Profit financing, i.e. undistributed profit or change in retained earnings, is defined as the funds provided by operations Q less depreciation D, interest expense I, income taxes T, and dividends V.

The theoretical depreciation ratio D is estimated from (29). Formula (28) is used instead if the more detailed information required by (29) is not empirically available. The depreciation policy of a business enterprise is described by comparing D with the observed ratio of depreciation on books, denoted Db. A positive difference Db-D indicates that the firm has utilized accelerated depreciation as a means of generating undisclosed profit financing. A negative difference indicates propped up disclosed profits. It should be stressed, however, that accelerating or decelerating depreciation is by no means the only way of adjusting disclosed profits. Depending on the legislation in the relevant country changes of reserves, deferring taxes, etc. can be used, too. In Finland utilizing an inventory write- off reserve (a kind of stock appreciation), allowed by tax-laws up to 50 per cent of the historical acquisition cost (FIFO), is of special importance in adjusting the disclosed profits in business practice._9

5.2 Long-Run Profitability, Growth, and Financing Behavior of Eight Major Finnish Pulp and Paper Firms

The empirical results concerning the eight most important Finnish firms producing mainly pulp and paper are given below. The firms are Enso Gutzeit (sales turnover in 1980 3745.2 million Finnish marks 10), Kajaani (FIM 804.6 million), Kaukas (1010.0), Kymi Kymmene (2028.2), Metsäliiton Teollisuus (1293.9), Wilh. Schauman (1542.9), Serlachius (1637.6), and Yhtyneet Paperitehtaat (2583.0). The analysis is based on deflated time-series for 1970-1980 derived from the financial statements of these firms. The time series are deflated in order to obtain the growth and profitability estimates in real terms. The information concerning the capital expenditures in the different classes was obtained from the firms. Because of space limitations the details of the statistical analysis of the time-series are not repeated here._11 For the same reason the empirical results are given in Table 1 without further interpretation._12

Image: Table 1

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5 For information see Artto (1980, pp. 27-29), and Yritystutkimusneuvottelukunta.

6 See Salmi (1982) for details.

7 See Luoma & Ruuhela (1980).

8 See Salmi (1980, pp. 17-20 and 27) for details.

9 See Jägerhorn & Troberg (1981) for the current accounting practices in publicly traded Finnish companies. For the relevant Finnish legislation a foreign reader is referred to Price & Waterhouse (1979).

10 The average exchange rates in 1980 were 1 USD = 3.730 EIM, 1 GBP = 8.691 FIM, and 1 DEM= 2.0558 FIM.

11 For the outlines of the statistical analysis see Salmi (1980, Ch. 3). One detail should be brought up here, in addition. For the capital expenditure classes of land, water, bonds and shares as well as construction in process the life-span is deemed infinite. Changes in net working assets are also treated as capital expenditures. These features are easily accomodated in the estimation by letting the relevant Nk:s go to infinity in formulas (16), (18), and (29).

12 A Finnish reader is referred to the writtings by Timo Salmi in the Finnish Business Daily (Kauppalehti) for analyses of Finnish firms in other branches. Ruuhela presented recently results on Finnish publicly traded companies also in Kauppalehti(16th March, 1982).


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Department of Accounting and Finance, University of Vaasa,
Finland

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