SSE/EFI Working Paper Series in Business Administration
No 2009:11:
Valuation Errors Caused by Conservative Accounting in Residual Income and Abnormal Earnings Growth Valuation Models
Kenth Skogsvik ()
and Beate Juettner-Nauroth
Abstract: The impact of conservative accounting in residual income
valuation (RIV) and abnormal earnings growth (AEG) valuation modeling is
investigated in this paper. Unconstrained and two types of constrained
model specifications are evaluated regarding their ability to withstand
biases in book values and earnings due to accounting conservatism. Given
that the “clean surplus relation” holds and that the precision of
forecasted accounting numbers is unaffected by the type of accounting
principles, the unconstrained valuation models are – not surprisingly –
found to be immune to conservatism. This does not hold for the constrained
models, even though conservatism can be accommodated in these if the
time-series specification of the conservative bias fulfils certain
conditions. In a comparison between terminal value constrained models, the
AEG model is found to be superior to the RIV model if the growth of the
conservative bias in the terminal period is not too extreme. Comparing the
information dynamics constrained models being proposed in Ohlson (1995) and
Ohlson & Juettner-Nauroth (2005), the AEG model is potentially more
accurate than the RIV model. However, in a company steady state setting
with constant growth, there is no comparative advantage for the AEG model.
Also, using the same set of forecasted accounting numbers in the
information dynamics constrained RIV model as in the corresponding AEG
model, the two models cannot be ranked.
Keywords: Abnormal earnings growth model; Accounting-based valuation; Conservative accounting; Financial analysis; Residual income model; (follow links to similar papers)
29 pages, April 22, 2009
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