Capital theory and depreciation

Our concern in the present paper is with an empirical evaluation of the relevance of published depreciation numbers. We report results of an attempt to assess the correspondence between the depreciation rates implied by published financial statements and the market-based rates implied by time series variations in corporate equity returns. Our modelling procedures are based on the ‘Crusonia plant’ construct, developed, in the first instance, by Frank Knight. This leads to a simple capital theory model under which firms are regarded as a reservoir of unused (homogeneous) capital services. Empirical results based on this construct indicate that estimated market rates of depreciation have a significant influence on corporate depreciation policies. Simple non-parametric correlation tests conducted at an industry level show that there is a significant association between book rates of depreciation and the market rates implied by an accumulation model based on Knight's ‘Crusonia plant’ construct.