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Asia-Pacific Journal of Accounting & Economics
ISSN: 1608-1625 (Print) 2164-2257 (Online) Journal homepage: http://www.tandfonline.com/loi/raae20
Value relevance of customer equity beyond
financial statements: evidence from mobile
telecom industry
Yong Bum Choi, Janghyuk Lee, Shijin Yoo & Yong Keun Yoo
To cite this article: Yong Bum Choi, Janghyuk Lee, Shijin Yoo & Yong Keun Yoo (2017): Value
relevance of customer equity beyond financial statements: evidence from mobile telecom industry,
Asia-Pacific Journal of Accounting & Economics, DOI: 10.1080/16081625.2017.1386575
To link to this article: http://dx.doi.org/10.1080/16081625.2017.1386575
Published online: 08 Oct 2017.
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Download by: [Tufts University]
Date: 28 October 2017, At: 05:59
Asia-Pacific Journal of Accounting & Economics, 2017
https://doi.org/10.1080/16081625.2017.1386575
Value relevance of customer equity beyond financial statements:
evidence from mobile telecom industry*
Yong Bum Choia, Janghyuk Leeb, Shijin Yoob and Yong Keun Yoob
a
Martin J. Whitman School of Management, Syracuse University, Syracuse, NY, USA; bBusiness School, Korea University,
Seoul, South Korea
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ABSTRACT
We investigate the extent of usefulness of customer equity (CE) estimate
in explaining market value of equity (MVE) and the determinants of the
discrepancy between CE estimate and MVE. Using the data of 17 companies
in the mobile telecom companies in 7 countries from 2004 to 2008, we find
(1) CE estimate provides incremental value relevant information to explain
contemporaneous MVE beyond financial statements, and (2) CE estimate
can predict future stock returns by indicating a part of temporal divergence
between MVE and a firm’s intrinsic value of equity.
ARTICLE HISTORY
Received 7 December 2015
Accepted 14 September 2017
KEYWORDS
Customer equity; market
value of equity; value
relevance
1. Introduction
Accounting and finance researchers have spent considerable effort investigating how to accurately
estimate firm value (e.g. Ohlson 1995; Dechow, Hutton, and Sloan 1999; Lee, Myers, and Swaminathan
1999; Easton et al. 2002). While they have focused on financial statements as the main information
source, it will be true that ‘other’ information outside financial statements is also useful for firm
valuation. This study seeks to find one important ‘other’ information by examining the information
contents of customer equity. Given that the incorporation of all available value relevant information
into firm valuation may improve valuation accuracy, whether customer equity provides additional
value relevant information is of interest for accounting and finance researchers.
The firm needs to understand its customers to develop and implement successful business strategies.
Many researchers have been investigating the linkage between the firm’s marketing actions and the
value for customers. However, measuring economic value of customers is also an equally important
task to fully understand the firm’s customers though its importance has been recently appreciated
by marketing researchers. As a response to this call, customer equity (CE) has been suggested as an
effective metric of the total value of customers and thus links marketing with other business functions
such as accounting and finance within an organization (Gupta and Lehmann 2005).
CE is a concept that understands customers as an asset for a firm to measure, manage, and maximize
like a financial asset (Blattberg and Deighton 1996; Gupta, Lehmann, and Stuart 2004). According to
this concept, marketing resources allocated to customers should be considered as an investment to
induce positive behavioral changes of the consumers in the future, not an expenditure to be consumed
CONTACT Janghyuk Lee [email protected]
*
Accepted by Jeong-Bon Kim upon recommendation by Oliver Rui
© 2017 City University of Hong Kong and National Taiwan University
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2 Y. B. CHOI ET AL.
and disappear. Under this perspective, CE can represent the firm’s intangible asset that reflects various
performance indicators such as brand equity, market power, or technological know-how in combination. Therefore, CE is believed to be an effective measure that can enhance the reliability of marketing
program’s accountability and long-term profitability (Reinartz and Kumar 2000; Gupta, Lehmann, and
Stuart 2004; Rust, Lemon, and Zeithaml 2004; Wiesel, Skiera, and Villanueva 2008).
Beyond its role as a measure for the value of customers, CE can also provide the equity value
related information to investors in stock market. This is because CE is based on the direct estimation
of a firm’s future expected cash flows from its customers, which in turn firm’s equity value consists
of. However, there is a paucity of evidence on the value relevance of CE, which is another important
metric to evaluate its usefulness. While Gupta, Lehmann, and Stuart (2004) and Kumar and Shah
(2009) document that CE estimate is closely associated with a corresponding firm’s market value of
equity (MVE), these studies do not show – and do not seek to show – the extent of usefulness of CE
to explain MVE. Furthermore, although they found the existence of a significant gap between CE
estimate and MVE, they did not further analyze any systematic mechanism behind the discrepancy.
For example, while previous studies suggest that the ignorance of risk factors (Kumar and Shah 2009)
or debt and non-operating assets (Schulze, Skiera, and Wiesel 2012) is a part of reasons for the discrepancy between CE estimate and MVE, those studies lack of a more comprehensive investigation
of the other determinants. Our study attempts to fill this void in the literature.
Specifically, we examine whether CE provides incremental value relevant information to explain
contemporaneous MVE beyond the information contents financial statements present. If CE does
not provide any incremental value relevant information beyond financial statements, CE would be
considered to simply repackage the information contents of financial statements and so to be useless at
least in explaining a firm’s equity value. Given that financial statements are the most important public
information which is necessary for investors to derive the equity value of the firm, the information
contents of financial statements will be a good benchmark to evaluate the extent of usefulness of CE
in explaining the firm’s equity value. By employing this specific benchmark for the extent of value
relevance, our study makes a more conclusive argument about the extent of value relevance of CE
than prior literature (e.g. Gupta, Lehmann, and Stuart 2004) which documents a positive association
between CE and MVE simply without any benchmark.
Then, we explore also whether CE estimate can predict future stock returns. Given that MVE is a
noisy proxy for the firm’s intrinsic value of equity, the discrepancy between CE and MVE may capture investors’ temporary mispricing of a firm’s equity value rather than measurement errors in CE
estimate. If CE estimate is less biased than MVE in incorporating value related factors in general, the
discrepancy between CE and MVE will indicate at least a part of temporal divergence between MVE
and the firm’s intrinsic value of equity, and so will predict a future movement of stock prices which
will converge into the firm’s intrinsic value of equity as time goes. Given that it is unclear whether
CE estimate incorporates value related factors more (or less) properly than MVE in general, it is an
empirical question whether CE estimate has the prediction power for future stock returns, which is
another metric to evaluate the usefulness of CE.
In addition, we investigate which factors explain the discrepancy between CE estimate and MVE.
Given that both metrics are the noisy proxies for the unobservable intrinsic value of equity of the
firm, it is possible that CE estimate may not properly incorporate the relevant information for a firm’s
intrinsic value of equity by a greater extent than MVE, and vice versa. We posit that some firm-level
characteristics, which CE estimate and/or MVE incorporate into their valuation by a differing extent,
will lead to the discrepancy between CE estimate and MVE. If CE estimate is more biased than MVE
in incorporating some value related factors, we can improve the accuracy of CE estimate by reflecting
such factors in its estimation. To the contrary, if CE estimate incorporates some value related factors
more properly than MVE does, investors can refer to CE estimate to conduct a more efficient and less
biased equity valuation.
The rest of the article is organized as follows: In the next section, we review the relevant literature
on the relationships between CE and a firm’s equity value and develop our research hypotheses. Section
ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 3
3 describes our methodology, data-set, and the measurement of CE. Section 4 presents our main
empirical results. Finally, we draw implications for researchers and practitioners and discuss further
research issues as concluding remarks in Section 5.
2. Background and hypotheses development
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2.1. Literature review
Researchers have attempted to reveal the relation of marketing actions with the firm value to enhance
marketing’s accountability. In particular, as the global financial investment market has evolved, the
increased recognition that the outcome of all strategic decisions of a firm will be eventually incorporated in market value of equity has accelerated this trend of research. For instance, Srivastava, Shervani,
and Fahey (1998) showed the process how the marketing related assets, such as customer relationship,
channel relationship, and partner relationship, affect a firm’s market value of equity. Ittner and Larcker
(1998) showed the impact of customer satisfaction level on the firm performance indicators such as
retention, revenue, and revenue changes. Anderson, Fornell, and Mazvancheryl (2004) and Fornell et
al. (2006) revealed the positive relationship between customer satisfaction and a firm’s market value of
equity. There are diverse studies which have examined the links between marketing actions and firm
value, such as brand relationship and firm value (Rao, Agarwal, and Dahlhoff 2004), new product
announcement and firm value (Sorescu, Shankar, and Kushwaha 2007), negative consumer voice and
stock return (Luo 2007), and advertising and firm value (Joshi and Hanssens 2010).1
Several marketing researchers also have focused on the value of customers. They show interests
about studies of marketing strategies which can evaluate, manage, and enhance the value of customers
(Blattberg and Deighton 1996; Gupta, Lehmann, and Stuart 2004; Rust, Lemon, and Zeithaml 2004;
Venkatesan and Kumar 2004). At the core of this line of research, there is a concept of customer lifetime value (CLV), which is defined by the discounted stream of cash flows generated over the lifetime
of a customer. Although the measurement of CLV is slightly different across industries with respect
to the relationship between the firm and the customer (Dwyer 1997), the metric provides a basis to
understand the value of marketing asset in terms of longer-term profitability, which can be used in
measuring return on marketing investment. Based on this concept of CLV, researchers define customer equity as the sum of CLVs of all customers including existing and expected ones in the future
(Blattberg, Getz, and Thomas 2001; Gupta, Lehmann, and Stuart 2004).
The direct association between CE and MVE has been explored by numerous researchers as well
(Gupta, Lehmann, and Stuart 2004; Kumar and Shah 2009; Libai, Muller, and Peres 2009). In particular,
Gupta, Lehmann, and Stuart (2004) state that traditional financial index, such as price-to-earnings ratio
(PER), is not applicable to explain a certain kind of business (e.g. dot-com companies on the Internet).
They suggest that CE can be an alternative metric to measure such firm’s value by documenting highly
positive association between CE and MVE. Kumar and Shah (2009) suggest an MVE prediction model
using CE and other relevant variables, such as volatility and vulnerability that are reflected in MVE
but not in CE. They show that the actual MVE is very close to the predicted MVE from their model,
suggesting that some risk factors are the variables that significantly affect the CE–MVE relationship.
Recently, Libai, Muller, and Peres (2009) estimate and compare the CE and MVE of seven companies
in four different service industries. They divide attrition rate into dis-adoption, the case where a customer stops using the service category itself, and a churn, the case where a customer leaves for rival
companies. They suggest a model which considers the influence of these factors to CLV and customer
diffusion curve, and find that six of seven companies show similar monetary values between their CE
and MVE. Based on the assumption of stock market efficiency, which allows us to derive reversely CE
from market value of equity, debt, non-operating assets and tax, Schulze, Skiera, and Wiesel (2012)
find the leverage effect of CE on MVE is 1.55 on average from over 2000 listed companies in US. They
also report CE with infinite time horizon fits the bracket of min and max MVE from the case of two
internet-based companies over multiple periods (Table 1).
Current paper
Schulze, Skiera, and Wiesel (2012)
Computer and retail; 2 firms in US
Estimate of CEs are very close to MVE;
Retail, financial service, radio, mobile telecom; 7
Considering attrition improves the estimation of CE
firms in 3 countries
in service industry
Study 1: Leverage effect of CE on MVE
Over 2000 listed companies in US;
Study 2: Multi-year comparison of CE and MVE
Netflix and Verizon
CE–MVE relationship
Mobile telecom; 17 firms in 7 countries
• Incremental value relevance of CE estimate beyond
financial statement in explaining MVE
• Usefulness of CE estimate to find mispriced stock
• Determinants of CE–MVE discrepancy
Kumar and Shah (2009)
Libai, Muller, and Peres (2009)
Industry/sample
Internet retail and financial service; 5 firms in US
Findings
High positive correlation between CE and MVE;
High R2 when MVE is regressed on CE and the coefficient of the CE is approximately 1
Estimate of CE, with risk factors, improves MVE
prediction
• Volatility and vulnerability of the firm’s cash flow
from customers
Paper
Gupta, Lehmann, and Stuart (2004)
Table 1. Literature review on customer equity and market value of equity.
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Aggregate level;
Individual level
Aggregate level
Aggregate level
Individual level
Data
Aggregate level
4 Y. B. CHOI ET AL.
ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 5
Although these studies examined the association between CE and MVE as a metric that proves the
appropriateness of CE from the perspective of marketers, however, they did not investigate further the
extent of usefulness of CE from the perspective of investors in stock market. Furthermore, they did
not analyze a comprehensive set of factors which may cause the discrepancy between CE and MVE.
Thus, we will examine how CE is incrementally useful for investors beyond the most representative
and easily accessible set of value relevant information, i.e. financial statements, in terms of explaining contemporaneous MVE and predicting future stock returns. In addition, to shed some lights on
how to improve the quality of CE estimate itself, we will investigate a comprehensive set of potential
determinants of the discrepancy between CE and MVE.
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2.2. Measurement of customer equity
This section describes how to measure CE in this study as well as in prior literature. There exist two
types of measurement for CE according to data availability and managerial objectives (Kumar and
George 2007). First, CE estimation based on internal data (e.g. transactions or managerial judgments)
can be viewed as an inductive or disaggregate approach that can assess the individual-level CLVs of all
customers and sum them up to get the firm’s CE (e.g. Venkatesan and Kumar 2004). This approach is
particularly useful to segment customers in terms of their long term contribution to a firm. By combining the firm’s marketing data (e.g. a time series of price promotion), managers can also examine
the implication of a firm’s marketing actions on its CE. However, understanding and reflecting the
behaviors of competing companies’ customers are unavailable in this approach.
On the other hand, the firm’s CE can be also measured using external data such as panel data,
consumer surveys, and company reports. This aggregate method enables outsiders who have limited access to the firm’s proprietary data to estimate the CE values of various firms. The weakness of
this approach is that researchers have to estimate CE from a representative customer inferred from
aggregated data, which cannot show individual differences among customers. For instance, Gupta,
Lehmann, and Stuart (2004) estimated the CLV of an average customer from publicly available financial data and multiplied the average CLV by the number of customers to derive a firm’s CE. Since the
objective of this article is to empirically investigate the relationship between CE and a firm’s value of
equity based on publicly available data in a multi-firm setting, we will follow the aggregate method,
suggested by Gupta, Lehmann, and Stuart (2004), which does not require individual-level customer
transactions data.
More specifically, an average CLV from a representative customer acquired at time k can be
expressed as;
CLVk =
∞
∑
(
)
ARPUi ⋅ AMi − RCi
i=k
r i−k
− ACk
(1 + d)i−k
(1)
where ARPU: average revenue per user; AM: average contribution margin; RC: retention cost; AC:
acquisition cost; r: retention rate; d: firm-specific time discount factor; i: time period; k: time period
of customer acquisition.
Unlike Gupta, Lehmann, and Stuart (2004), we assume that the customer’s revenue (ARPU), contribution margin (AM), retention cost (RC), and acquisition cost (AC) will vary across calendar
time rather than each customer’s length of tenure with the firm, since the metrics tend to be highly
influenced by the firm’s marketing actions (Yoo and Hanssens 2005).2 Due to the lack of available data
with respect to the allocation of marketing costs, we assume that the ratio of retention cost to the
total marketing spending is proportional to the firm’s market share in the mobile telecommunications
industry. We incorporate both current and future customers to calculate CE, since we evaluate the value
of customers from time t to infinity in Equation (2). If there are nk number of customers acquired at
time k, then CE evaluated at time t (t ≤ k) will be;
6 Y. B. CHOI ET AL.
CEt =
∞
∑
nk
k=t
(1 + d)k−t
[
∞
∑
)
(
⋅
ARPUi ⋅ AMi − RCi
i=k
r i−k
− ACk
(1 + d)i−k
]
(2)
We calculate the magnitude of CE for 17 mobile telecommunications service providers in 7 countries
for 5 years (i.e. from year 2004 to year 2008) based on non-proprietary data. More details regarding
the measurement and operationalization of each variable are presented in Section 3.
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2.3. Hypotheses development
This section develops our main hypotheses to be tested. First, while several studies report that CE
is closely associated with contemporaneous MVE (e.g. Kumar and Shah 2009), these studies do not
further investigate whether investors can get incremental value relevant information from the value
of customers, measured by CE, beyond easily accessible public information. Since accounting and
finance literature concludes that financial statements provide much information which is relevant for
investors to evaluate a firm’s equity value, we consider the information contents financial statements
present as the benchmark to evaluate the incremental value relevance of our CE estimate. Without
such a benchmark, it is not possible to evaluate the incremental usefulness of CE to investors in stock
market. Thus, our first empirical hypothesis (in an alternative form) is as follows.
Hypothesis 1: Customer equity provides incremental value relevant information beyond financial statements to
explain contemporaneous market value of equity.
Second, to address a potential concern that MVE, our benchmark for the firms’ intrinsic value of
equity when testing Hypothesis 1, is also a noisy measure of true intrinsic value, we also investigate
whether our CE estimate can predict future stock returns. If the discrepancy between CE and MVE
captures investors’ temporary mispricing of a firm’s equity value rather than measurement errors in
CE estimate, our CE estimate will help predict future stock returns over the period during which
market value of equity converts to its intrinsic value. As a measure of the divergence between CE
and MVE, we propose the ratio of CE to MVE (CM ratio, hereafter). If our CE estimate successfully
captures at least a part of temporal divergence between MVE and the firm’s intrinsic value of equity,
higher (lower) CM ratio will indicate the undervaluation (overvaluation) of the firm’s value of equity,
which leads to positive (negative) abnormal stock returns in the future. Thus, we construct our second
alternative hypothesis as follows.
Hypothesis 2: The firm’s future stock return is positively associated with CM ratio.
Even though our CE estimate can provide value relevant information to explain the firm’s contemporaneous MVE, there still exists a significant discrepancy between CE estimate and MVE across firms.
For example, while Gupta, Lehmann, and Stuart (2004) found reasonably similar CE estimate as MVE
for three out of five firms, two firms – Amazon and eBay – showed substantial differences between the
two values. Thus, we will investigate the potential determinants of the discrepancies between CE and
MVE, which will be helpful to improve the quality and so the usefulness of our CE estimate.
While using CM ratio as a focal variable to understand the discrepancy between CE and MVE
across firms, we categorize various explanatory factors into three groups on the assumption that both
CE and MVE are noisy proxies for the firm’s intrinsic value of equity. The first group includes the value
relevant factors that investors may incorporate less properly into MVE than our CE estimate. The
second group includes the value relevant factors that our CE estimate does not fully incorporate while
investors do. We classify the other factors to which CE and MVE would react by a differing extent in
unexpected directions as the third group. For each group, we bring related theoretical backgrounds
and set up hypotheses that will be tested by our empirical analysis as follows.
ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 7
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2.3.1. Complementary factors to market value of equity
Contrary to the efficient market hypothesis, previous research pointed out some factors that make
the firm’s market value of equity deviate from its intrinsic value of equity. We list up two major ones
with their perspectives.
2.3.1.1. Sales growth rate. Lakonishok, Shleifer, and Vishny (1994) find that firms with higher past
sales growth earn lower subsequent stock returns suggesting that investors overvalue the firms’ higher
past sales growth. That is, when a firm reports higher sales growth rate in previous year, investors tend
to over-estimate the future revenue, and thus the firm’s value of equity. Therefore, the stock price of
firm with higher past sales growth rate will deviate upward from the intrinsic value at a point of time.
To the contrary, the implication of past sales growth to future revenue will be adequately incorporated
into our CE estimate through the reasonable consideration of customer retention rate and average
revenue per user. In this case, our CE estimate will not overreact to past sales growth rate in terms of
forecasts of future revenue. That is, our CE estimate will be relatively lower than market value of equity
for a firm with higher past sales growth rate. Thus, CM ratio may capture investors’ overreaction to past
sales growth by presenting a lower value for firms with higher past sales growth rate. Consequently,
if CM ratio has an ability to capture investors’ over-evaluation of past sales growth, the firms’ sales
growth rate will be negatively associated with CM ratio as in the following alternative hypothesis.
Hypothesis 3-1: Sales growth rate is negatively associated with CM ratio.
2.3.1.2. Market-to-book ratio. Lakonishok, Shleifer, and Vishny (1994) also suggest that higher
(lower) market-to-book ratio (MTBR) indicates investors’ overvaluation (undervaluation) of equity
value relative to the used net assets which are the proxy for the firm’s fundamental on the balance sheet.
Thus, they report that firms with relatively high (low) MTBR tend to show lower (higher) subsequent
stock returns. However, MTBR is less likely to be associated with high or low CE estimate, since our
CE estimate is mainly calculated by using the income statement information (e.g. revenue per user
and contribution margin) and other operational reports (e.g. retention rate). As a result, we expect that
higher (lower) MTBR leads to smaller (greater) CM ratio. Thus, we set up the following hypothesis.
Hypothesis 3-2: Market-to-book-ratio is negatively associated with CM ratio.
2.3.2. Complementary factors to customer equity
Although there exist some advantages as described in Section 2.2, our estimation of CE from secondary data is also embedded with some systematic limits to approximate the firm’s intrinsic value
of equity, compared with investors’ equity valuation. We propose three factors that our CE estimate
may not fully incorporate, creating a systematic discrepancy between CE and MVE as follows: firm
size, non-operating income, and the revenue share of focal business within the firm.
2.3.2.1. Firm size. We use the firm-year specific discount rate to estimate CE of each firm by
applying Weighted Average Cost of Capital (WACC) based on the Capital Asset Pricing Model
(CAPM). However, it is necessary to customize further the discount rate in line with the firm’s other
risk characteristics, notably the size of the firm. Penman (2004) discusses the importance of liquidity
in explaining the cost of capital, and Amihud and Mendelson (1986) argue that firm size is a good
proxy for liquidity. Firm size is further identified as a risk proxy by Fama and French (1995). They
suggest that the cost of capital (in turn, discount rate) will be lower (higher) for bigger (smaller) firms.
Even though there does not exist any systematic conversion rule from the firm size to the appropriate
discount rate, we can hypothesize that CE will be underestimated (overestimated) for bigger (smaller)
firms since their true discount rate will be relatively lower (higher). Since the denominator, MVE, may
adequately incorporate the firm size factor in investors’ application of discount rate, the CM ratio is
expected to be smaller (greater) for bigger (smaller) firms due to the underestimated (overestimated)
numerator, CE. Therefore we construct the following hypothesis.
8 Y. B. CHOI ET AL.
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Hypothesis 3-3: Firm size is negatively associated with CM ratio.
2.3.2.2. Non-operating income. Although operating income is the main component of firms’
profitability, non-operating income also consists of firms’ overall profitability. While investors may
incorporate the comprehensive income (sum of operating and non-operating income) into MVE,
our CE estimate incorporates only the operating income. This is because our CE measure captures
only the profits from customers while ignoring the other non-operating income, such as gains from
asset disposals and foreign currency translation gains etc. Thus, our CE estimate will be relatively
underestimated (overestimated) for the firms with higher (lower) proportion of non-operating income.
Schulze, Skiera, and Wiesel (2012) also propose that MVE is sum of customer equity and non-operating
assets (minus debt and tax paid) in balance sheet. If there exists a positive relationship between
non-operating assets and non-operating income, the theoretical relationship suggested by Schulze,
Skiera, and Wiesel (2012) also supports the above hypothesis. Thus, we expect that CM ratio is smaller
(greater) for firms with higher (lower) proportion of non-operating income due to the underestimated
(overestimated) numerator, CE. Therefore, we construct the following hypothesis.
Hypothesis 3-4: The proportion of non-operating income is negatively associated with CM ratio.
2.3.2.3. Share of focal business. Compared to MVE that encompasses the firm’s value of equity in
total, our CE estimate is based on the specific performance indicators, such as customer base, average
revenue, cost of customer acquisition and retention, and retention rate, from a focal business unit (i.e.
mobile telecommunications service in our empirical setting). If a company owns multiple business
units, the separate estimation of CE for a focal business unit may neglect to incorporate the synergy
effect among multiple business units within a firm. For example, customers exposed to multiple
business units of a firm may show higher probability of cross-purchases, resulting in higher customer
values. While investors incorporate such a synergy effect properly into MVE, our CE estimate ignores
such indirect values of customers. As a result, high share of a focal business unit, the inverse of synergy
effect, positively influences the CM ratio as in the following hypothesis.
Hypothesis 3-5: The share of a focal business unit is positively associated with CM ratio.
2.3.3. Ambivalent factors
We list up the other factors to which CE and MVE would react by a differing extent in unexpected
directions as the third group. Thus, each factor’s relationship with the CM ratio remains as an empirical
question without directional hypothesis developed a priori.
2.3.3.1. Loyalty program. Customer loyalty increases revenue, enhances retention rate, and reduces
cost to acquire and retain customers (Reichheld 1996). Firms in diverse industries, including the mobile
telecommunications industry, are implementing loyalty programs to increase customer loyalty and
thus the value of their customers. However, loyalty programs under certain circumstances may not
be effective (Liu and Yang 2009). Depending on the program’s cost effectiveness (Reinartz and Kumar
2002), the existence of loyalty programs may lead to increase both customer equity and market value
of equity by a differing extent. We cannot develop a directional hypothesis regarding this factor since
the direction depends on the relative appreciation of a loyalty program by customers and by investors.
If customers more (less) appreciate the value of a loyalty program than investors do, the firm’s CM
ratio may be positively (negatively) associated with the existence of loyalty programs.
Hypothesis 3-6: The existence of loyalty programs is associated with CM ratio without a priori direction.
2.3.3.2. Market share. Market share is positively related to business profitability (Szymanski,
Bharadwaj, and Varadarajan 1993), and amplifies the positive impact of business actions (e.g.
innovation) on the firm’s market value (Blundell, Griffiths, and Van Reenen 1999). Though it is not
ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 9
required to report market share in financial statements, it is one of the important factors that determine
the firm’s equity value. Likewise, high share firms tend to have a high level of customer equity due to a
bigger customer base, a higher level of marketing investment for customer retention, better reputation,
etc. However, the relative magnitude of the reaction of CE estimate and MVE to market share is an
empirical question. For example, high share firms may show lower customer satisfaction due to the
customer’s higher expectation (Anderson, Fornell, and Lehmann 1994), which may negatively affect
the total value of customers. Therefore, we develop a non-directional hypothesis as follows.
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Hypothesis 3-7: Market share is associated with CM ratio without a priori direction.
2.3.3.3. Cross-selling efforts. Like customer loyalty programs, the firm’s cross-selling efforts may
positively affect both CE and MVE. Since the firm’s top- and bottom-line performance can be improved
by successful cross-selling efforts (e.g. product bundle packages), more cross-selling efforts will increase
a firm’s MVE. The firm’s CE also will be improved by successful cross-selling efforts due to the direct
increase through higher retention rate (i.e. customers may repeatedly purchase the focal product from
the firm due to attractive cross-purchase opportunities) and indirect increase through higher crosspurchases (i.e. customers can contribute more to the firm by purchasing other products provided
by the firm). Firms may also be able to acquire more new customers by allocating more marketing
resources to customer acquisition given effective cross-selling results from existing customers. In
fact, the fundamental equation of customer equity proposed by Blattberg, Getz, and Thomas (2001)
includes cross-selling efforts as an important component of CE. However, it is not clear whether our
CE estimate appreciates the cross-selling efforts more or less than MVE does. We therefore hypothesize
that the CM ratio will be associated with the firm’s cross-selling efforts without any a priori direction.
Hypothesis 3-8: Cross-selling efforts are associated with CM ratio without a priori direction.
3. Methodology and data
3.1. Methodology
This section describes how to test our hypotheses. First, to empirically examine our first hypothesis,
we need to measure the overall value relevance of financial statements as a benchmark and also the
incremental value relevance of CE as the other information beyond financial statements. To achieve
this purpose, we employ a specific equity valuation model developed by Ohlson (1995; hereafter
Ohlson model). This is because Ohlson model expresses the equity value as a linear function of summary information from financial statements and the other information beyond financial statements
as described below.3
First, Ohlson (1995) assumes that firms’ equity value is equal to the present value of expected
future dividends:
]
[∞
∑ DIVt+n
Assumption 1: dividend discount model; Vt = Et
(
)n
(3)
n=1 1 + COEt
where Vt is the firm’s equity value at time t, DIVt is the dividends net of capital contributions during
period t, and COEt is the firms’ cost of equity capital at time t.
Then, Ohlson (1995) imposes the basic structure of accounting system, called as clean surplus
relation, into the dividend discount model. This assumption allows future dividends to be expressed
in terms of future earnings and book values of equity, which leads to express the firm’s equity value
as a function of those accounting information:
Assumption 2: clean surplus relation; BVt+1 = BVt + Et − DIVt
where BVt is the firm’s book value of equity at time t, Et is the earnings during period t.
(4)
10 Y. B. CHOI ET AL.
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Lastly, Ohlson (1995) applies the following assumption about the autoregressive process of abnormal earnings (see the definition below) and the other information beyond abnormal earnings. This
assumption specifies the nature of the relation between future earnings and current information within
or outside of financial statements:
Assumption 3: linear information dynamics; AEt+1 = AEt + t + 1(t+1)
(5)
t+1 = t + 2(t+1)
(6)
where AEt is the abnormal earnings which is defined by (Et − COEt * BVt−1), υt is the information
other than abnormal earnings, and ε1t and ε2t are the disturbance terms which are unpredictable zero
mean variables.
By combining these three assumptions, Ohlson (1995, 670) expresses a firm’s equity value as a linear
function of reported book value of equity (as summary information from balance sheet) and reported
earnings (as summary information from income statement) with the other information, which indicates the value relevant information contents beyond financial statements as follows:
Vt = 1 BVt + 2 Et + 3 t
(7)
Since Ohlson (1995) introduced this simplified but theoretically driven equity valuation model,
accounting researchers have thoroughly investigated and widely accepted the Ohlson model due to
its systematic link from accounting information to equity value. Thus, many accounting researchers
have used the Ohlson model for various research purposes. For example, Dechow, Hutton, and Sloan
(1999) investigate the ability of the Ohlson model to explain the cross-sectional distribution of a firm’s
market value of equity. Then, Collins, Maydew, and Weiss (1997) and Francis and Schipper (1999) use
the Ohlson model to examine the change of value relevance of financial statements for last 40 years
in US stock market. Furthermore, Ali and Hwang (2000) also use the Ohlson model to examine the
inter-country differences of value relevance of financial statements across various countries.
Following previous literature in this area, we evaluate the overall value relevance of financial statements by its ability to explain the cross-sectional distribution of firms’ market value of equity, which
is measured by the adjusted R2 of the following regression equation4:
MVEt = 0 + 1 BVt + 2 Et + u1t
(8)
where MVEt is the firm’s market value of equity at time t, and u1t is the error term.
While Equation (8) ignores the other information which is not available on financial statements,
we explicitly consider our measure for customer equity as the other information beyond financial
statements as in following Equation (9)5:
MVEt = 0 + 1 BVt + 2 Et + 3 CEt + u2t
(9)
where CEt is the measure of customer equity at time t.
Then, we measure the incremental value relevance of customer equity beyond financial statements
by the differences of adjusted R2 between the regression Equations (8) and (9). If our CE estimate
provides incremental value relevant information beyond financial statements, we will observe the
significant increase of adjusted R2 from the regression Equations (8) to (9), which will support our
first hypothesis.
To test our second hypothesis of whether our CE estimate can predict future stock returns, we form
a quintile portfolio of firms based on the magnitude of CM ratio by each year then examine the mean
differences of one-year-ahead stock returns across quintiles. If our CE estimate can indicate the temporal divergence between MVE and intrinsic value of equity, the firms within the quintile with lower
(higher) value of CM ratio will show lower (higher) one-year-ahead stock returns. In this analysis,
we assume that the market value of equity will convert to its intrinsic value within a year, which is a
standard in accounting and finance literature. In addition, stock returns we use in our analysis refer to
ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 11
the firm-idiosyncratic cum-dividend stock returns, which are defined as firm-specific cum-dividend
stock returns over the market portfolio returns (Fama and French 1993, 2005; Campbell et al. 2001;
Luo 2007). Since investors’ mispricing of equity value will be restricted to a specific group of firms
rather than the whole stock market, it is desirable to focus on abnormal firm-specific stock returns over
the influence of market factors (e.g. global financial risk) to examine the conversion of market value
of equity into its intrinsic value. Thus, we measure the abnormal cum-dividend stock returns of individual firms by deducting the market portfolio returns from individual cum-dividend stock returns.
Lastly, we investigate the determinants of the discrepancy between the firm’s CE estimate and MVE
by regressing the firm-level CM ratio on several firm-specific characteristics as follows.
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CMit = 0 + 1 SGRWit + 2 MTBRit + 3 SIZEit + 4 NOINit
+5 STBUit + 6 LOTYit + 7 MSHRit + 8 CRSLit
+1 DEBTit + 2 PENEit + 3 IGRWit + 4 YEARt + it
(10)
According to our Hypotheses 3-1 and 3-2, we include two complementary factors to market value
of equity: past sales growth rate (SGRW) and market-to-book ratio (MTBR). We expect that the
coefficients of these two variables, ψ1 and ψ2, will be negative. Next, following our Hypotheses 3-3,
3-4, and 3-5, we add three complementary factors to CE estimate, firm size (SIZE), non-operating
income (NOIN), and share of the mobile telecommunications business unit (STBU). We posit that
the coefficients of SIZE and NOIN (ψ3 and ψ4) are negative while that of STBU (ψ5) is positive. In
addition, to test our Hypotheses 3-6, 3-7, and 3-8, we include the other ambivalent factors, such as
customer loyalty programs (LOTY), market share (MSHR), and cross-selling efforts (CRSL), into the
regression equation. For these variables, we do not have any ex-ante expectation of the directional
association with the CM ratio.
Lastly, to control for the well-known leverage effect on the discrepancy between CE and MVE
(Schulze, Skiera, and Wiesel 2012), we include debt-to-asset ratio as a control variable. In addition,
to control for the potential country- and time-specific factors, we include two country-level variables,
such as the penetration rate of mobile telecommunications (PENE) and market index growth rate
(IGRW), as well as a year dummy variable (YEAR).6
3.2. Sample selection
We empirically test research hypotheses proposed in the previous section with a data-set collected
from the mobile telecommunications industry. We selected this industry for the current study due to
several reasons. First, since many firms in the mobile telecommunications industry regularly unveil
critical information (e.g. the number of customers, churn rate, and average revenue per user) necessary to calculate CE, this industry fits well to our current investigation even though we cannot access
to any internal proprietary data (e.g. individual transactions data). Second, most firms in the mobile
telecommunications industry are listed on the stock market so that we can easily obtain financial
statement information required to conduct our empirical analyses. Moreover, since the mobile telecommunications business unit is a major strategic business unit for most of sample firms,7 we can
more directly compare CE with MVE. Third, since the nature of business in the mobile telecommunications industry is relatively similar in most of countries, we can increase the degree of freedom by
pooling the data-set from different countries. Lastly, by focusing on one industry, we can control for
any systematic difference across various industries in testing our research hypotheses.
We selected 17 firms in the mobile telecommunications industry of 7 countries mainly from Asia
Pacific region (Australia, Canada, China, Japan, South Korea, United States) and Belgium as our
sample.8 We first obtained the number of customers of these firms up to 12 years before 2008 given
data availability. This information will be used to estimate the future number of customers, a critical
component to calculate our CE estimate for each firm. We then obtained annual financial information
data for five years from 2004 to 2008 to conduct our empirical analyses.9 All the data were obtained
Firm
Hutchison
Australia
Telstra
Belgacom
Mobistar
Bell
Rogers
Telus
China Mobile
China Unicom
KDDI
NTT Docomo
KTF
LGT
SKT
AT&T
Sprint Nextel
Verizon
30,000
49,073
6626
3809
9269
49,335
30,427
49,322
30.8
54.6
14.4
8.2
23.0
77.0
40.3
72.1
9.3
4.8
3.7
6.5
7.9
6.1
457.3
133.4
9075
2802
2065
3677
5198
3823
60,439
12,261
41.09
54.33
21.65
11.65
33.49
102.01
51.81
93.58
11.29
9.37
5.49
7.11
10.43
7.38
649.72
147.58
α
2.75
−1.98
−1.64
−2.04
−1.90
−1.66
−3.72
−3.99
−2.59
−1.78
−0.63
−2.04
−2.31
−2.46
−2.68
−4.08
−4.06
β
−5.56
0.25
0.45
0.25
0.24
0.20
0.38
0.51
0.29
0.27
0.05
0.22
0.35
0.28
0.32
0.40
0.89
γ
0.50
0.100
0.025
0.756
0.427
0.148
0.128
0.297
0.072
0.040
0.775
0.193
0.050
0.099
0.082
0.366
0.089
MAPE
0.417
62.2
62.7
37.0
33.4
41.6
50.0
59.0
50.0
55.1
53.3
48.0
44.3
47.8
53.9
11.7
7.2
ARPU (USD)
85.9
23.2
27.7
26.9
25.6
44.5
24.4
18.2
36.2
35.9
39.2
39.0
40.8
38.8
34.4
47.4
31.5
Margin (%)
0.5
2.6
4.1
3.4
1.2
3.1
2.0
1.0
2.0
2.6
0.0
1.3
2.6
2.6
1.7
1.0
0.5
Retention
cost (USD)
2.6
380.4
309.2
119.7
177.3
239.1
146.0
191.0
213.0
150.0
41.3
145.3
236.5
155.7
201.7
19.2
33.4
Acquisition
cost (USD)
1.207.7
1.15
0.84
2.97
3.16
1.99
2.12
2.59
1.34
1.73
1.40
2.03
1.52
1.89
1.42
1.42
2.33
Churn rate
(%)
1.57
33.8
109.1
2.1
0.9
20.8
123.4
−13.0
161.8
15.7
12.2
13.2
8.1
12.8
10.7
692.1
16.3
CE (USD
billion)
1.7
Notes: This table contains the sales and the number of customers of mobile telecommunications business unit of the firm in 2008. α means the firm’s expected number of customers (in millions) as time
approaches infinity. MAPE is an average mean absolute percentage error between March 2004 and March 2008. ARPU (average revenue per user, monthly) = sales/the number of customers/12, margin
(monthly) = (total revenue − (operating expenses − marketing expenses))/total revenue, retention cost (monthly) = marketing expenses * market share/the number of customer/12, acquisition cost
(annual) = marketing expenses * (1 − market share)/the number of new customers, and churn rate (monthly) are computed based on each firm’s annual report.
United States
South Korea
Japan
China
Canada
Belgium
Country
Australia
Number of
Customers
(million)
2.0
Sales (USD
million)
2310
Table 2. Descriptive data and estimated parameter of sample firms.
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12 Y. B. CHOI ET AL.
ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 13
from secondary data sources such as annual reports, company websites, and databases such as Data
Stream and fnguide.com. We also obtained data from Journal of Mobile Communications, marketresearch.com, and celluar-news.com to complement our data. Finally, our sample consists of 85 firm/
year observations from distinct 17 firms. Table 2 presents the description of our sample companies as
well as their CE parameter estimates.
3.3. Measurement of variables
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This section describes how to measure some key components of our CE estimate and other variables
for our empirical analyses with their distributions.
3.3.1. The number of customers
Since our measurement of CE estimate includes the value of future customers, we need to estimate the
number of customers in the future. As the customer growth of each firm in our sample shows a very
similar pattern as a conventional diffusion theory, we follow the diffusion model applied in Gupta,
Lehmann, and Stuart (2004). The number of customers (N) at time t is modeled as:
Nt =

1 + exp (− − t)
(11)
where α, β, and γ are parameters to be estimated from the past data. Therefore, considering the
retention rate r, the number of newly acquired customers (n) at time t can be calculated as follows10:
nt = Nt − rNt−1
(12)
The parameter estimation results for customer growth are provided in Table 2. Mean absolute percentage error (MAPE) shows that our model reflects the actual growth pattern quite closely. Although the
sum of ultimate market potential (α) within some countries is greater than the current population of
those countries (e.g. 66.8 million vs. 48.6 million for Korea), it seems reasonable considering the high
mobile penetration rate in several countries. For instance, the penetration rates of most European
countries are higher than 100%, and those of Korea, Australia, Hungary, Italy, and Hong Kong are
94, 110, 120, 156, and 163% respectively (Wireless federation and China wireless news, April, 2009).
3.3.2. Average contribution margin
It is necessary to separate marketing costs from the other operating expenses to estimate customer
equity as proposed in Equation (1). However this task is challenging for some firms since detailed
marketing costs are not required items to be posted in the financial reports for most of countries. For
instance, US firms disclose only selling, general and administrative (SG&A) costs and provide limited
information about advertising costs. Due to this lack of disclosure of detailed marketing costs in many
countries, we define marketing costs as the sum of advertising, promotion, and other selling costs. In
particular, we apply the industry average ratio of marketing costs to SG&A among Canadian firms to
the firms in the US and Japan, where firms are not required to separately report the marketing costs.
In the case of firms that only report the consolidated expenses with other business units (e.g. cable TV
business), we apply the revenue share of mobile telecommunications business to total revenue in order
to obtain the cost information only for the focal business unit. We do not include acquisition costs
(AC) in Equation (13) since AC is separately incorporated in CLV and CE calculation in Equations
(1) and (2), respectively. Therefore, the average contribution margin (AM) in Equation (13) is before
acquisition costs. As a result, the average contribution margin (AM) at time t is obtained from the
following equation.
AMt =
Total Salest − Total Operating Costst + Marketing Costst
Total Salest
(13)
14 Y. B. CHOI ET AL.
Table 3. Variable operationalization, data sources and descriptive statistics.
Variables
CE
MVE
CM
BV
E
SGRW
MTBR
SIZE
NOIN
STBU
LOTY
MSHR
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CRSL
DEBT
PENE
IGRW
Measurement
See Section 3.1
Stock price × number of shares
CE/MVE
Book value of common equity
Net income
Mobile sales growth rate
MVE/book value of common equity
Log of total assets (USD)
Operating margin – net margin
Mobile business sales/total sales
Yes = 1/No = 0
Firm’s share of mobile market based on
sales
The number of bundled services (unit)
Debt/asset ratio
The penetration rate of mobile telecommunication
Local stock market index growth rate
Sources
Annual Reports
Data Stream
Data Stream
Data Stream
Annual Reports
Data Stream
Annual Reports
Annual Reports
Annual Reports
Annual Reports
Annual Reports
Annual Reports
Annual Reports
Annual Reports, KISDI, Journal of Mobile
Communication
Data stream
Mean
1.746
1.013
0.992
0.408
0.064
0.106
2.415
10.315
0.098
0.708
0.412
0.344
Std. dev.
1.745
0.764
4.050
0.237
0.075
0.119
1.577
0.578
0.102
0.303
0.495
0.144
3.235
0.548
0.738
1.212
0.175
0.202
0.127
0.152
Notes: This table reports the variable operationalization, data sources and descriptive statistics of main variables used in our tests.
We used pooled data of 17 firms from 2004 to 2008 (N = 85). ‘CE’ is customer equity measured annually, ‘MVE’ is firm’s market value
of equity at the end of March of each year, ‘BV’ is book value of common equity, and ‘E’ is net income. ‘CE’, ‘MVE’, ‘BV’ and ‘E’ are
converted into US dollars and scaled by total assets. The values of ‘MVE’, ‘BV’ and ‘E’ are adjusted by multiplying the firm’s ratio of
mobile sales to total sales. ‘CM’ is CM ratio which is equal to CE divided by MVE. ‘SGRW’ is past sales growth rate, ‘MTBR’ is marketto-book ratio, ‘SIZE’ is firm size in terms of total assets, ‘STBU’ is share of the mobile telecommunications business unit, ‘LOTY’ is
a dummy variable for the existence of loyalty programs, ‘MSHR’ is market share of the firm in local mobile telecommunications
market in terms of sales, and ‘CRSL’ is cross-selling efforts of the firm, measured by the number of bundled services. For the control
variables, ‘DEBT’ is the total debt divided by total asset, ‘PENE’ is penetration rate of mobile telecommunication, and ‘IGRW’ is stock
market index growth rate in each local market.
3.3.3. Retention rate
The customer churn rate is regularly reported in the mobile telecommunications industry. Most of firms
include annual or quarterly churn rate in their annual reports because the number of subscribers is one
of the most important metrics directly related to the firm’s profitability in this industry. Moreover, as
customers are allowed to switch service providers without changing their existing phone numbers in
most countries, effective management of the churn rate has become a major concern of the industry.
We use one minus annual average churn rate as our estimate for retention rate.
3.3.4. Distribution of variables
By using the estimated components consisting of CE based on Equation (1), we estimated annual
values of CE for our 17 sample firms from 2004 to 2008. Since we were not able to observe any pattern in margins, acquisition costs, retention costs, and retention rates, we decided to use an average
of previous 2 years for each metric to estimate the current CE.
To estimate CE, we use firm-year specific discount rate by applying Weighted Average Cost of
Capital (WACC) based on the Capital Asset Pricing Model (CAPM). More specifically, to calculate the
cost of equity capital, we have regressed at least 12 prior monthly stock returns against corresponding
country’s stock market index up to 60 months preceding the current period to estimate market beta.
The resulting market beta estimate is used in conjunction with realized treasury-bill rates in each
country as risk-free rates and 7% as the market risk premium. Then, we estimate the cost of debt capital
by the ratio of interest expenses relative to total debt on the financial statements. Lastly, we calculate
WACC by the weighted average of cost of equity and cost of debt capital, where the respective weight
is market value of equity or book value of debt relative to the sum of those two values.
Each firm’s CE is scale-adjusted by the size of total assets resulting in a mean value of 1.746. Table
3 summarizes how to measure main variables for our empirical analyses with corresponding data
sources, and presents the basic statistics such as mean and standard deviation of each variable.
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ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 15
Since annual reports and other financial statements are posted around March in most countries, we
use data from the end of March in one year to the end of March in next year to measure stock market
related variables. We obtained monthly market value of equity (MVE) by multiplying monthly stock
prices by monthly total number of outstanding shares of a firm (i.e. market capitalization). We then
picked a firm’s MVE at the end of March of each year. We defined book value of equity (BV) as the
book value of common equity, and annual earnings (E) as net income. Note that market value of equity,
book value of equity, and earnings are adjusted by the revenue share of mobile telecommunications
business within a firm to fairly evaluate multi-business firms. As in the CE variable, the three variables
are also scale-adjusted by total assets. As explained earlier, CM ratio (CM) was obtained by dividing
each firm’s CE by MVE. The average CM across all observations is 0.992 with a standard deviation of
4.050, which shows diverse distribution.
We obtained past sales growth rate (SGRW) of the mobile telecommunications business from
sample firms’ annual reports (mean = 10.6%). Market-to-book-ratio (MTBR) was calculated by MVE/
BV (mean = 2.415). The firm size (SIZE) variable was obtained from natural logarithm of total assets
to minimize a scale issue (mean = 10.315), and non-operating income (NOIN) from deducting net
margin from operating margin (mean = 0.098). The revenue share of mobile telecommunications
business (STBU) was calculated by dividing revenue of mobile telecommunications business by the
firm’s total revenue (mean = 0.708).
Three ambivalent factors were also obtained from annual reports of each firm. The existence of
loyalty programs (LOTY) is dummy coded with one if a firm provides any program, zero otherwise (mean = 0.412). Market share (MSHR) stands for the firm’s revenue share in a corresponding
country’s mobile telecommunications industry (mean = 0.344). For measuring cross-selling efforts
(CRSL), we counted the number of bundled services (e.g. cable TV) with mobile telecommunications
(mean = 3.235). As a firm-level control variable, Debt-to-Asset ratio (DEBT) has the mean of 0.548.
Two country-specific control variables were collected from various sources (e.g. Journal of Mobile
Communication). We measured the penetration rate of mobile telecommunications (PENE) and the
growth rate of stock market index (IGRW) for each country.
4. Empirical results
This section documents our main empirical results.11 First, we test our first hypothesis of incremental
value relevance of CE estimate by comparing the adjusted R2 between the regression Equations (8)
and (9).
As reported in Table 4, the explanatory power (measured by adjusted R2) of two summary information from financial statements on contemporaneous MVE is 0.638. However, when adding our CE
estimate into the regression, it increases into 0.729. This result indicates that our CE estimate provides
incremental value relevant information beyond financial statements and so investors may be able to
Table 4. Incremental value relevance of customer equity.
MVEt = α0 + α1 BVt + α2 Et + u1t
Model 1
Model 2
Variables
Coefficients
BV
−0.075
E
8.305***
MVEt = β0 + β1 BVt + β2 Et + β3 CEt + u2t
Std. Error
0.260
0.819
Variables
BV
E
CE
Std. Error
0.232
1.184
0.044
Coefficients
0.248
3.219***
0.238***
Adj. R2
0.638***
Adj. R2
Changes
0.729***
0.091***
Notes: N = 85. This table reports the results of regression analyses for Model 1 and 2. See the note of Table 3 for the definition of
variables.
***p < .01.
16 Y. B. CHOI ET AL.
Table 5. Difference of abnormal stock returns among groups based on CM ratio.
Between groups (ANOVA)
Multiple comparison (LSD)
Group
1
2
3
4
5
Total
N
15
20
16
19
15
85
Mean
0.075
−0.049
0.044
−0.137
−0.210
−0.058
Mean difference from group 5
0.285
0.161
0.254
0.073
F
3.401
Sig.
0.013**
Std. error
0.094
0.088
0.092
0.089
Sig.
0.003***
0.071*
0.007***
0.417
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Notes: N = 85. This table reports the mean of one-year-ahead abnormal stock returns for each quintile portfolio based on CM ratio.
We use pooled data of annual stock returns. Each group is divided in accordance with rank of CM ratio by year. The group with the
highest (lowest) CM ratio is named as Group 1 (Group 5).
*p < 0.10; **p < 0.05; ***p < 0.01.
Table 6. Determinants of CM ratio.
Adj. R2
Model
(Constant)
SGRW
MTBR
SIZE
NOIN
STBU
LOTY
MSHR
CRSL
DEBT
PENE
IGRW
YEAR
Coefficients
27.367
−0.340
0.363
−2.335
−26.541
0.224
−2.998
7.855
1.149
−6.625
−0.231
−4.589
−0.307
Std. error
8.855
2.448
0.205
0.786
3.626
0.372
1.155
2.929
0.288
2.365
2.061
2.305
0.275
Sig.
0.003***
0.890
0.082*
0.004***
0.000***
0.549
0.011**
0.009***
0.000***
0.007***
0.911
0.050**
0.268
0.711***
Hypothesized direction
H3-1 (−)
H3-2 (−)
H3-3 (−)
H3-4 (−)
H3-5 (+)
H3-6 (+/−)
H3-7 (+/−)
H3-8 (+/−)
Notes: N = 85. This table reports the result of pooled regressions of the following equation. See the note of Table 3 for the definition
of variables.
*p < 0.10; **p < 0.05; ***p < 0.01.
CMit = 0 + 1 SGRWit + 2 MTBRit + 3 SIZEit + 4 NOINit
+5 STBUit + 6 LOTYit + 7 MSHRit + 8 CRSLit
+1 DEBTit + 2 PENEit + 3 IGRWit + 4 YEARt + it
get more value relevant information by considering the value of customers. Furthermore, note that
the coefficient of earnings decreases from 8.305 to 3.219 before and after adding our CE estimate
respectively, while the coefficient of book value of equity remain insignificant for both regressions. This
result implies that our CE estimate may subsume a part of information contents of reported earnings
to explain contemporaneous market value of equity, which is natural given that our CE estimate is
measured based on information from income statement.
Second, we test our second hypothesis on whether CE estimate can predict future stock returns by
examining the mean differences of one-year-ahead stock returns across quintiles, which are formed
on the basis of the magnitude of CM ratio.
As reported in the third column of Table 5, the firms within the quintile with the lowest CM ratio
(Group 5 in Table 5) show the lowest mean of one-year-ahead abnormal stock returns (−21.0%) while
the other groups present stock returns between −13.7 and 7.5%. The results of ANOVA show that the
differences of one-year-ahead abnormal stock returns among five groups are significant (sig. = 0.013).
The last column of Table 5 reports the result of least-significant difference (LSD) tests showing that the
differences of one-year-ahead abnormal stock returns between Group 5 and the other three groups
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ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 17
(except Group 4) are statistically significant (p < 0.10). Although we cannot observe the monotonic
pattern of abnormal stock returns proportional to the magnitude of CM ratio as our second hypothesis
expects, it is clear that our CE estimate may capture at least the overstated market value of equity of the
firms within the extreme quintile with the lowest CM ratio, whose one-year-ahead stock returns are
significantly lower. Thus, we conclude that our CE estimate is useful for investors to identify overvalued
stocks by capturing the divergence between overstated market value of equity and its intrinsic value.
Lastly, Table 6 documents the results of regression of CM ratios on various firm characteristics to
identify the determinants of the discrepancy between CE estimate and MVE.
First, we find that the coefficients of firm size (SIZE) and non-operating income (NOIN) are significantly negative which is consistent with our Hypotheses 3-3 and 3-4, respectively. This result indicates
that our procedure to estimate CE may ignore these two pieces of important value relevant information, and so investors can improve the CE estimation procedure by considering these factors. Second,
while past sales growth rate (SGRW) is negatively associated with CM ratio and share of the mobile
telecommunications business unit (STBU) is positively associated with CM ratio, as our Hypotheses
3-1 and 3-5 expect, the associations are not statistically significant. One of possible reasons for this
result is the weak testing power due to the small number of sample (85 observations). Third, regarding
ambivalent factors, the existence of customer loyalty programs (LOTY) shows significantly negative
coefficient, while market share (MSHR) and cross-selling efforts (CRSL) are significantly positively
associated with CM ratio. This result suggests that while investors may more appreciate the value of
a loyalty program than customers do, our CE estimate reacts further to the effect of market share on
future profitability and to the higher retention rate and more purchasing by successful cross-selling
efforts than investors do. In addition, while the coefficient of market-to-book ratio (MTBR) is positive,
which is contradictory to our Hypothesis 3-2, such an association is found to be marginally significant.
Taken together, we identify firm size, non-operating income, the existence of customer loyalty
programs, market share, and cross-selling efforts as the potential determinants of the discrepancy
between our customer equity estimate and contemporaneous market value of equity. We believe that
this finding will be helpful for researchers and practitioners to improve the quality of CE estimation
procedure and to further understand the appreciation of marketing actions by investors and customers.
5. Discussion and conclusion
As Levitt (1960) suggested in his seminal paper, the firm needs to buy customers and sell satisfaction to
generate repeating purchases from its customers, which stressed out that the firm’s operational focus
should lie in customers not in products or services. Following this perspective, many firms have spent
lots of marketing effort to provide superior value for customers and in turn to get the maximum value
of customers. Furthermore, marketing investments should be linked with the firm value in theory, but
this task is challenging in practice due to a blurry causal link between the firm’s marketing actions and
the firm value in stock market. Many firms’ shareholders and CEOs have concerns about the long-term
financial contribution of marketing investment beyond its role on conventional marketing metrics
such as customer satisfaction and market share. Customer equity has been proposed as a new metric
to link between marketing and other functions (e.g. finance and accounting) within an organization
by quantifying the value of customers.
This paper explores the role of CE as the source of value relevant information for investors in the
stock market. We show that CE, a proxy of the firm’s equity value from marketing perspectives, provides investors with incremental value relevant information beyond financial statements to explain
contemporaneous market value of equity. In other words, CE can be considered by investors as a
significant piece of other information incorporating the value of (arguably most important) intangible asset of firms, the value of customers, which is not captured by conventional financial reports.
Thus, marketing can be connected to other managerial fields within an organization through CE. For
example, the impact of marketing efforts on firm value can be measured by investigating how CE is
moving according to different levels of marketing investments.
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18 Y. B. CHOI ET AL.
We also find that CE can indicate the investors’ temporal mispricing of the firm’s equity value. This
result implies that investors in the stock market may be biased in incorporating the impact of marketing
actions on firm value but that they can reduce such a bias by referring to CE. Therefore, CE will be
able to contribute to the enhancement of stock market efficiency, which is a necessary condition for
the efficient allocation of limited resources in the economy.
We also document that several key determinants account for the discrepancy between CE and MVE,
of which the extant literature fails to provide a deeper investigation. CE estimate should be adjusted
by firm-level characteristics such as firm size and non-operating income to more accurately approximate the firm’s market value of equity (or intrinsic value of equity). More specifically, since a firm’s
non-operating income is not incorporated in the conventional calculation of CE, a metric based on
customer values from a fundamental business operation, our measurement of CE tends to underestimate the value of equity for firms with a relatively high level of non-operating income. In addition, the
measurement of CE should consider firm size to apply more appropriate firm-specific discount rate.
On the other hand, there are other significant factors that affect the relationship between CE and
MVE such as loyalty programs, market share, and cross-selling efforts. First, the service providers’
loyalty programs in the mobile telecommunications industry are less effective in customer acquisition
and retention than investors expect. Though further research is required, this result proposes that
loyalty programs may have signaling and spillover effects as advertising on market value of equity
(Joshi and Hanssens 2010). Second, the financial market seems to less appreciate high market share
than customers do. Third, the firm’s cross-selling efforts by providing other related services such as
the broadband Internet may increase the synergy among related business more than investors expect.
These findings also improve our understanding of the CE–MVE relationship.
As a closing remark, there are also several limitations of this study that open areas for further
research. First, although we aimed to extend the literature on the CE–MVE relationship, our results
are based only on one industry under the lost-for-good business circumstance (Dwyer 1997). To
generalize our results, similar research on various industries should confirm our findings. For example, investigating industries under non-contractual setting (e.g. personal computers) will provide
an interesting comparison to our findings. Second, a temporal change of the CE–MVE relationship
within a firm would be worthwhile to examine. Though we could not investigate such issues due to
the limited number of data points in the current paper, longer time-series will enable researchers to
study a dynamic nature of the CE–MVE relationship. For example, it will be interesting to examine
how the changes in a firm’s business portfolio affect the CE–MVE relationship. Third, competition and
interaction among rivalry firms would play an important role on the CE–MVE relationship as well.
Models that explicitly accommodate the competitive nature of firms will be necessary to understand
this phenomenon. Finally, one can obtain a more complete picture of the CE–MVE relationship if
a firm’s internal data (e.g. customer-specific transactions history) complement our proposed methodology in calculating customer equity. For example, decomposing acquisition and retention costs
based on the firm’s accounting data (if any) will provide more accurate CE estimate. We leave all these
issues for future research.
Notes
1. See Srinivasan and Hanssens (2009) for a comprehensive review on this issue.
2. Gupta, Lehmann, and Stuart (2004) also used calendar-time-based metrics in their empirical investigation due
to the lack of individual-level data. However, this assumption may not hold for business-to-business industries
where the tenure of each customer significantly affects the metrics (i.e. ARPU, AM, RC, and AC).
3. See Ohlson (1995) for the details of how to theoretically derive Ohlson model.
4. All regression variables are scaled by the book value of total assets to address scale issue.
5. The market value of equity, book value of equity, and earnings in our studies are adjusted values which are
multiplied by the ratio of mobile telecommunications business sales to total sales of the firm. This is because
our customer equity estimate is based on the sales of mobile telecommunications business even though the firm
may have multiple business units. This adjustment will enhance the comparability across variables.
ASIA-PACIFIC JOURNAL OF ACCOUNTING & ECONOMICS 19
6. See Section 3.3 for the details of how to measure the variables.
7. An average revenue share of mobile telecommunications business is 70% across all sample firms.
8. We rule out the firms operating in multiple countries since it is hard to figure out the contribution of each
country’s market to the items in consolidated financial statements.
9. We measure the market value of equity at the end of March of each year to allow investors to incorporate the
information contents of annual reports which are required to be announced by the three months after the
December fiscal-year end in most countries.
10. We use the same approach of Schulze, Skiera, and Wiesel (2012) to calculate the future number of customers
in this study. Equations (11) and (12) in our paper are identical with Equations (4) and (5) in Schulze, Skiera,
and Wiesel (2012), respectively.
11. We winsorize all variables at the top and bottom 3% of pooled distributions of each variable to minimize the
bias from extreme values in all of our empirical analyses.
Disclosure statement
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No potential conflict of interest was reported by the authors.
Funding
This study was supported (partially) by Korea University Business School Research Grant.
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