An Alternative to the Feltham-Ohlson Valuation
Framework: Using q-Theoretic Income to Predict Firm Value
Miles B. Gietzmann
Cass Business School City University
Adam Ostaszewski
Dept. of Mathematics
London School of
EconomicsMay 2003, altgo-conf.tex
AbstractIn this model we provide a theoretical justi¯cation for why the
代写留学生毕业论文 functional relationshipbetween earnings and value will be non linear. Moreover in our stylized model we derivea closed form for the relationship and show why earnings response coe±cients are lower
for ¯rms that are contracting or expanding relative to those ¯rms that are maintaininga steady investment
strategy. We extend earlier research which posits a simple convexrelationship based upon ¯xed abandonment values and also generalize research which usesreal options valuation models based upon the assumption that ¯rms only ever exercise
one real investment option and then are committed to that strategy ad in¯nitum. Inparticular, since in some empirical settings the special case of `¯xed' abandonment willnot apply, we show how the form of convexity changes. Secondly, in our model ¯rmsare allowed to dynamically change investment strategies, for instance expanding in one
period followed by contraction in the subsequent period. Given an objective of derivingcomparative statics results for earnings response coe±cients, our dynamic model is ableto capture more accurately real investment behavior than a model in which ¯rms onlyever decide to expand or contract once. Our model provides both an alternative rationale
for
Accounting measures having information content and an alternative framework for theempirical speci¯cation of tests of `accounting value relevance' based upon ¯nite mixture(regime-switching) distributions. Our model shows how one can view equity value ascomprising opening cash, q-revalued opening stock, current q-income and future q-income.We are grateful for comments from Nick Bingham, Graham Brightwell, Patricia Dechow,Mike Kirschenheiter, Russ Lundholm, John O'Hanlon, and from seminar participantsat the University of Lancaster, EIASM Madrid
Economics and Accounting workshop,and at King's College London.
1
1 INTRODUCTION
In this section we discuss the established Feltham-Ohlson (FO) valuation model and brie°y
review the main ¯ndings and some related research. We argue that, since the FO approach
has no transparent role for management, the approach excludes consideration of important real
options that typically arise empirically when investment decisions are undertaken. In addition,
we present a simple example that shows that the traditional residual income number is not the
only accounting measure which admits valuation equivalence to the discounted dividend stream.
Another well-known criticism, following Peasnell (1982), of the clean surplus class of models,
such as FO, is that the models do not give rise to any structural implications for the application
of accounting rules. That is, it may be hard to argue that the models present a justi¯cation for
accrual accounting when there is little evidence of the need for accrual adjustments. Exploiting
this equivalence type result we show that a di®erent form of residual income valuation does
give rise to a reasonably tractable method for analyzing optimal investment decisions and
develops an approach to go beyond the general
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