3oumd of BUrin~ss Finance B Accounting, 23(2), March 1996,0306-686X

DISCUSSIONOF ARE PETROLEUM MARKET VALUES A TRIUMPH OF ECONOMICS OVER ACCOUNTING?

KEVIN HOLLAND*

The current paper differs in a number ofways from the paper presented a t the Capital Markets Conference, 1995. My comments are mainly restricted to the current version of the paper, though, where appropriate, reference will be made to the conference version by way of a note.

The objectives of the paper are to ‘review the state of the debate regarding the value of accounting disclosures as compared to supplementary and proprietary data in the valuation of oil and gas companies’ and to overcome what the authors identify as two key problems in the existing literature. First, that previous research ‘tested the value of supplementary data before the investment community developed experience with the information’, and second that these researchers (Miller and Upton; Harris and Ohlson) ‘lacked a comprehensive data set that included all key variables’.

This first criticism raises an interesting point as to the initial demand for the supplementary disclosures.’ Did accountants take the lead by starting to supply information that the investment community had not demanded? This is in contrast, for example, to the experience ofinflation accounting in the UK, where Morris (1 975) attributed the absence of a market response to the fact ‘that the incidence of inflation at an industry level had already been discounted into prices [. . .]’. However, he also speculated that ‘it may also indicate a certain distrust of the figures’. This second explanation supports the authors’ contention.

The authors’ approach is to use a multivariate regression to ‘investigate the factors that influence (my italics) the market value ofoil and gas companies’. The regression takes the form of simultaneously regressing share price on four alternative measures of firm value. The four measures differ in the valuation attributed to the ‘proven petroleum reserves’ and are summarised as follows:

BV or HOT or PV or KEA + BV of other assets BV of liabilities Number of shares of common stock

- -

where: BV = book value of proven petroleum reserves, HOT = hotelling valuation of proven petroleum reserves, PV = present value of proven petroleum reserves, and

The author is a Lecturer and ICAEW Research Fellow in the Department of Accounting and Finance, University of Wales, Aberystwyth.

Address for correspondmcm Kevin Holland, Department of Accounting and Finance, University ofwales, Aberystwyth, UK.

QBlackwell Publishen Ltd. 1996,108 Cowley Road, Oxford OX4 IJF, UK and 238 Main Street, Cambridge, MA 02142, USA. 263

264 HOLLAND

KEA = proprietary valuation of unproven and proven petroleum reserves.

I have a number of points concerning the valuations. The authors classify the BV and PV methods as ‘accounting values’ and the H O T and KEA as ‘economic values’ in an attempt to determine which sources of data ‘investors generally focus on’. However, the validity of the classification is questionable. Clearly accounting valuations of ‘other’ assets and liabilities are included in all four valuation methods and accounting estimates are also included in arriving a t the ‘proven petroleum reserves’ valuations under both the H O T and KEA methods (see p. 245 and Table 1 respectively). For these reasons care should be exercised in attributing associations to a particular source, accounting or economic. There is an additional issue as to the comparability of the valuation methods. Unlike the three other methods, the KEA valuation specifically includes ‘unproved oil and gas assets’ (Table 1, step 5). As one would anticipate share prices to reflect ‘unproved oil and gas assets’ it is reasonable to expect, teteris paribur the KEA valuation to explain a greater proportion of the variation in share price, compared to other valuation methods that exclude ‘unproved oil and gas assets’.‘ The authors refer to this point in note 1 1 but the effect of the their inclusion is unclear. My final point on the variables concerns the level of multicollinearity between the independent variables. The authors provide bivariate correlations but do not report any multivariate analysis, e.g. auxiliary regressions nor condition indices to assist in an evaluation of the extent of the multicollinearity. This is of particular interest given the unexpected negative sign on the PV coefficient as reported in Table 3.

The regression is initially estimated on a sample of 461 observations covering the period 1987-1991 and subsequently for each of the five years in the p e r i ~ d . ~ Interpreting the eleventh column of Table 4 as giving the White corrected t-statistics, all four variables are statistically significant at the 1 % level for the pooled sample (though PV with an ‘incorrect sign’). However, by individual year, a different picture emerges. Althought H O T and KEA are significant in four of the five years, PV and BV are significant only in 1988. The authors conclude on the basis of these results and the specification tests reported in Table 5 that, ‘while MP (share price) is closely related to HOT and KEA in most periods, one cannot say that economic variables such as H O T and KEA are always the critical determinants of MP in contrast to BV and PV’.4

In summary, for the reasons stated above I would refrain from grouping the valuations methods in any interpretation and in particular would like to see results based on a revised definition of the KEA variable which excludes ‘unproved oil and gas assets’. I do of course appreciate that the authors are restricted by the format of the data provided to them, though an approximate adjustment may have been possible. What this paper and earlier studies does show is that results tend to be sample specific: for example, HOT is significant

Q Bladtwtll Publishers Ltd 1996

DISCUSSIONOF PETROLEUM MARKET VALUES 265

in this study and Miller and Upton (1985), but not in Harris and Ohlson (1987). This may indicate that the models ought to control for other factor^.^ For example, variations in uncertainty levels may favour one valuation method over another, or there may be firm specific characteristics that ought to be considered, e.g. experience in profitably locating and developing fields. The results of this study highlight the importance of fully replicating earlier studies over differing sample and time frames in order to assess the stability of earlier results and conclusions.

NOTES

Cairnie (1985) discusses the introduction of SFAs69. It is not clear from Miller and Upton (1985) how the proprietary data set they use, the Herold valuations, treats unproved oil and gas assets. The conference version of the paper used 261 observations covering the period 1985-1990. The conference version concluded that ‘this empirical research suggests a shift in focus by investon from book value (BV) and Hotelling measure (HOT) to supplementary data (PV) and proprietary data (KEA). However, the conference version used a different dependent variable, Imputed value per equivalent barrel, and partitioned the sample between successful efforts and full cost firms (this is consistent with Miller and Upton, 1985, and Harris and Ohlson, 1987). The constant in the full sample model implies a share price of $2.94 for a company with zero net assets. This represents 14.9% of the mean share price for the sample period.

1 2

3 4

5

REFERENCES

Cairnie, T. R. (1985), ‘Oil and Gas Accounting: A Review of the Issues and Priorities”, Accounting and

Harris, T. S. and J. A. Ohlson (1987), Accounting Disclosures and the Market’s Valuation of Oil and

Miller, M.H. and C W. Upton (1985),‘ATest of the Hotelling Valuation Principle’, Journal of poliricuf

Morris, R (1975), ‘Evidence of the Impact of Inflation Accounting on Share Prices’, Accounfing and

Business Rcscanh, No. 58 (Spring), pp. 113-122.

Gas Properties’, Accounfing RcvicqVol. 62 (October), p p 651-670.

Economy,Vol. 93, pp. 1-25.

Bm‘ness Rcseurch (Spring), pp. 82-90.

0 Blackwell Publishen Ltd 1996