A strong relationship between the firms' financial ratios and their security characteristics is observed when canonical correlation analysis is applied instead of trying to measure the volatile relationships between the individual variables. It is seen from a sample of 32 firms for 1974-84 that the key ratios in the relationship differ over time. Furthermore, it is observed that accrual-based ratios relate more significantly than the cash-based ratios to the security characteristics. Cash-based ratios are incrementally significant, though. To establish a relationship between the financial ratios and the security characteristics a limited number of temporally varying key ratios is sufficient. Finally, it is observed that in assessing security characteristics the expected returns and beta are sufficient. Higher moments have no incremental significance.
Keywords: Financial statement analysis, accrual-based ratios,
cash-based ratios, association of ratios, canonical
correlation
Timo Salmi, ts(a)uwasa.fi
Professor of Accounting and Business Finance
Ilkka Virtanen, itv(a)uwasa.fi
Professor of Operations Research and Management Science
Paavo Yli-Olli, pyo(a)uwasa.fi
Professor of Accounting and Business Finance
Presented at EURO XII/TIMS XXXXI Joint International Conference: Operational Research Management Science, Helsinki, Finland, June 29-July 1, 1992.