Lemmings to the Sea: The Inappropriate Use of Financial Ratios in Empirical Analysis

Milken Institute Working Paper No. 2001-01

19 Pages Posted: 25 May 2001

See all articles by Susanne Trimbath

Susanne Trimbath

STP Advisory Services, LLC; Creighton University, Department of Finance and Economics; Bellevue University - College of Business

Date Written: May 2001

Abstract

Despite the theoretical underpinnings for the use of equity and earnings in economic analysis, certain financial ratios are not suited for econometric models. In particular, when reported shareholder's equity and/or earnings are less than zero, an inverse relationship can exist between financial ratios and actual firm performance. Although certain earnings ratios can be corrected when this happens, corrections to other ratios, in particular those involving negative book values for equity would result in severe sample bias, erroneous results, and misleading conclusions.

Keywords: Return on equity, Financial ratios, Sample bias, Leverage ratios, Use of accounting data in economics

JEL Classification: B41, C81, G29, G30

Suggested Citation

Trimbath, Susanne, Lemmings to the Sea: The Inappropriate Use of Financial Ratios in Empirical Analysis (May 2001). Milken Institute Working Paper No. 2001-01, Available at SSRN: https://ssrn.com/abstract=270342 or http://dx.doi.org/10.2139/ssrn.270342

Susanne Trimbath (Contact Author)

STP Advisory Services, LLC ( email )

PO Box 1252
Bellevue, NE 68005
United States
4029328888 (Phone)

HOME PAGE: http://www.STPAdvisors.com

Creighton University, Department of Finance and Economics ( email )

United States

Bellevue University - College of Business ( email )

United States

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