Vertical integration and value-relevance: Empirical evidence from oil and gas producers

Abstract

Oil and gas exploration companies (E&Ps) exhibit large variations in earnings due to volatile oil and gas prices. Furthermore, their primary asset, oil and gas reserves, is accumulated through highly risky exploration activities. In contrast, integrated oil and gas companies display lower variability in their earnings due a more diversified asset base. The literature suggests that companies with higher earnings volatility and higher levels of intangibles among their assets should have lower value relevance of accounting information than companies with higher levels of tangible assets on their balance sheets. For that reason, E&P companies should have lower value relevance than integrated companies. Contrary to expectations, we do not find lower value relevance for E&Ps earnings than integrated oil and gas companies. In fact, the results suggest that the presence of supplementary estimates for oil and gas reserves values mitigate the potential problem associated with the presence of intangible assets experienced in other industries.

Keywords:

• company valuation
• value-relevance
• oil and gas industry
• vertical integration
• valuation
• oil majors
• oil integrateds
• exploration & production
• E&P

JEL codes:

• M21
• M40
• G12
• Q49

Public Interest Statement

The oil and gas sector is a large and important industry. The sector comprises a wide variety of companies, from companies specialized in upstream oil and gas exploration and production activities (E&Ps), to companies that are engaged in both upstream and downstream (processing, transportation and marketing) activities, to firms providing a wide range of services (oil service companies). This study examines the importance to investors of financial statement information supplied by oil and gas companies. We specifically address the topic if the relevance for investors of accounting information is affected by degree of vertical integration. Certain characteristics such as volatile earnings, choice of accounting method, type of assets inaccurate accounting methods vary between E&Ps and Integrateds. We ask if these traits lead to structural changes in the importance to investors of earnings information. Consistent with our expectations, we find that the relevance of earnings vary with changing vertical integration.

Acknowledgement

The author wishes to thank IHS Herold for supplying the data used in this study.

Additional information

Notes on contributors

Bård Misund

Bård Misund is associate professor of Accounting and Finance at the University of Stavanger Business School. He has 10 years of industry experience from commodities companies. Before starting as a professor at the University of Stavanger, he worked as an economic analyst, and later as an advisor to the Norwegian oil and gas company Statoil ASA. His research covers several fields including accounting, finance and economics, mostly covering topics related to commodity markets. Research questions include commodity price behaviour, the spot-forward relationship in futures markets, determinants of commodity firm stock returns, financial statement analysis and valuation of oil and gas firms.