TABLE OF CONTENTS In the absence of definitive results regarding the pricing of net income in the earlier Internet valuation literature, a number of papers have focused on revenues and other components used to calculate net income in order to explain firm valuations. To date, however, little empirical research has been conducted on how revenues are created by these firms. This paper examines firm revenue creation, while addressing the potentially endogenous and multicollinear nature of the internet activity measures. This is accomplished through the development and testing of a path diagram (Figure 2), which specifies the route firms take from expenditures on SG&A and R&D through activity generation to revenue creation. This methodology allows for simultaneously addressing issues of factor identification and endogeneity. The focus on intermediate pathways permits separate testing of direct and indirect (through intermediate variables) effects. Its application is particularly appealing for Internet firms, where understanding these relationships should provide a clearer understanding of what is driving the valuations of these firms.
The path analysis methodology presented in this paper could be easily adapted to other areas of accounting research. In particular, it could be used to improve measurement of other variables by decomposing components or effects of accounting and non-financial data. For instance, evidence from this and other papers suggests that expenditures on SG&A and R&D might be regarded as investments and should therefore be capitalized. Path analysis could help address issues like these for all types of firms. It would allow...
