Equity valuation in practice: The influence of net financial expenses

• I analyse how net financial expenses associate with market prices of stocks.
• The empirical study finds that financial items are not value relevant under IFRS.
• The study concludes that equity values are driven by operating items.
• The residual operating income model is appropriate for equity valuation.

This study investigates the relevance of net financial expenses with respect to equity valuation in an IFRS accounting regime. According to the residual earnings valuation model, income related to balance sheet items that are recorded at fair value is not applicable for valuation purposes. There are no residual earnings associated with these items because the balance sheet provides ‘perfect’ value estimates for the items in question. In accordance with the contention that under IFRS, aggregate net financial liabilities are recorded at a book value that is close to fair value, this study demonstrates that net financial expenses are not associated with the market prices of stocks. The investigation discusses the empirical findings in light of the enduring controversies regarding the use of fair value accounting.