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Figure 1

Market value of equity as a function of expected earnings, holding adaptation value constant

Source: Burgstahler and Dichev (1997)

Note: The crossing point is of investor indifference where capitalized earnings (recursion value) are equal to adaptation value. For E > AV/c, investors are more willing to continue to operate the company using the current technology, while for E < AV/c, investors are more willing to adapt recourses to an alternative use.

2. Market value as a function of book value for fixed earnings

As a function of book value, the analysis of market value which holds earnings constant is similar to the analysis above. Rearranging and expanding the first equation as a function of AV for a fixed E, yields:

MV (AV, E) =cE +

In this form, the market value of equity on a condition that the sum of capitalized earnings plus the value of an option on downside protection can interpret a fixed level of expected earnings. That is to say, if the adaptation value proves superior the value of the firm, the value of a firm’s option to elect it is based on the earnings stream that is generated with the business technology at present. This equation provides the basis for a second proposition:

Proposition 2: On a condition of given expected earnings, market value is an increasing, convex function of adaption value.

In an intuitive sense, it holds because an increase in adaptation value provides additional downside protection for a fixed level of expected earnings. Furthermore, the higher the level of adaptation value associated with the fixed level of expected earnings, the larger the revision in market value relative to a revision in adaptation value. If the adaptation value is large associated with capitalized expected earnings, the business technology of the firm at present is inferior to alternatives, and adaptation value becomes the main determinant of market value of equity; recursion value is only a secondary determinant of market value of equity.

As is mentioned above, Burgstahler and Dichev (1997) found that the extent of association of equity values with earnings and book value depended on the level of success of the firm. When the firm is successful (high earnings), earnings is the more important determinant of equity value. While when the firm is less successful (low earnings), book value is the more important determinant of equity value. This finding is further confirmed by Collins et al. (1999). Specifically, it is concluded by Collins et al. (1999) that book value is an important factor to determine stock prices, especially for firms making loss. For firms that have a high probability of liquidating because of their financial losses, book value represents as a proxy for what they referred to as the “abandonment option”.

2.4 Studies examining Chinese stock market data

There are only a limited number of published studies that examine the variables driving equity value in the Chinese environment. The published research that is available has focus on the behavior of Chinese stock market and macro-control impact on the Chinese stock market. Liu et al. (2009) exa本论文由英语论文网提供整理，提供论文代写，英语论文代写，代写论文，代写英语论文，代写留学生论文，代写英文论文，留学生论文代写相关核心关键词搜索。