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The Usefulness of Current Cost Information for Identifying Takeover Targets and Earning Above-Average Stock Returns: Professional Adaptation

The Financial Accounting Standards Board (FASB) required certain publicly held companies to disclose supplementary current cost information for fiscal years that ended subsequent to December 25, 1979, and prior to December 3, 1986. Research has shown that current cost data, when used to form the ratio of a firm’s market value to the replacement cost of its net assets, are useful for determining the firm’s acquisition likelihood. This study provides additional evidence concerning the usefulness of current cost information for identifying takeover targets. Because above-average stock returns generally accrue to shareholders of takeover targets, the opportunity for achieving additional wealth is an incentive for investors to identify future targets. It is hypothesized that current cost information should be more useful than historical cost information for identifying future takeover targets and for earning above-average stock returns. Due to the existence of inflation, traditional historical cost-based financial statements may show illusory profits and mask the true financial condition of a firm. Current cost information, which reflects changes in both specific prices and general price levels, should be more useful for assessing profitability, cash flow prospects, and the ability of the firm to maintain its financial capital.