Measurement Of A Financial Model Of The Firm: A Field Study

Abstract

A financial model of the firm is a useful tool for corporate management in formulating and executing strategic company operations and in understanding past managerial actions. Yet, while financial models have evolved to simultaneously-determined systems which portray the myriad of interdependencies among accounting variables, measurement of their parameters typically relies on simple parsimonious techniques which are theoretically inferior. Accurate measurement of the parameters is important for reliable application of the mode3l, including what if analyses, managerial planning exercises, and production of pro forma reports. This article reports on a field study of the implications associated with using the commonly-employed ordinary least squares technique of parameter measurement for a financial model of the firm. The results show that parameter measurement using this simple estimation method are significantly different from those obtained from a theoretically superior technique. Decomposition of the measurement differences demonstrates an association with characteristics of both the firm and its environment; moreover, the differences are shown to be primarily attributed to the earnings-based relations of the model.