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Aggregation, Dividend Irrelevancy, and Earnings†Value Relations

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  • KENTON K. YEE

Abstract

In this paper I show that the aggregation of operating and financial income imposes three conditions on earnings†based value functions. These three conditions provide a shortcut way to identify dividend irrelevant value functions. For example, consider any value function Vt of book value bt, earnings xt, and dividends dt. The aggregation conditions imply that Vt must be of the form Vt = (1 − k)bt + k [f xt − dt]. f is the permanent earnings capitalization factor and undetermined weight k may be any function of Δt ≡[φxt − dt] − bt. The Ohlson 1995 model is the special case when k is constant. But generally k does not have to be constant to maintain dividend irrelevancy. Whenk varies with Δt, Vt is nonlinear in earnings. Hence, this result specifies how Vt may be nonlinear in earnings in settings with limited liability or production or abandonment options and still be dividend†irrelevant. An even more remarkable feature of this result is that it holds whether accounting is clean surplus or not. One must conclude that accounting†based valuation properly builds from accounting aggregation and Δt, and not from the clean surplus relation and abnormal earnings as many now believe.

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  • Kenton K. Yee, 2005. "Aggregation, Dividend Irrelevancy, and Earnings†Value Relations," Contemporary Accounting Research, John Wiley & Sons, vol. 22(2), pages 453-480, June.
  • Handle: RePEc:wly:coacre:v:22:y:2005:i:2:p:453-480
    DOI: 10.1506/GEH4-WNJR-G58F-UM0U
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    Cited by:

    1. Luc Paugam & Jean‐François Casta & Hervé Stolowy, 2018. "Non‐additivity in Accounting Valuation: Theory and Applications," Abacus, Accounting Foundation, University of Sydney, vol. 54(3), pages 381-416, September.
    2. Kenton K. Yee, 2006. "Earnings Quality and the Equity Risk Premium: A Benchmark Model," Contemporary Accounting Research, John Wiley & Sons, vol. 23(3), pages 833-877, September.
    3. Ed-Dafali, Slimane & Patel, Ritesh & Iqbal, Najaf, 2023. "A bibliometric review of dividend policy literature," Research in International Business and Finance, Elsevier, vol. 65(C).
    4. Sanna, Dario, 2020. "A Fast and Parsimonious Way to Estimate the Implied Rate of Return of Equity," MPRA Paper 102003, University Library of Munich, Germany.
    5. Bassam M. ABU-ABBAS, 2021. "The Role of Dividends on Equity Valuation: Evidence from the GCC Countries," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 162-180, June.

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