Dividend Irrelevance and Accounting Models of Value

Abstract

Abstract:In accounting models of value, dividends typically appear to have a strong positive relationship with value despite theoretical reasons to expect dividend displacement. We show that this result is driven by the relationship between dividends and both core earnings and other information derived from the valuation error in the prior year. Where core earnings can be effectively modelled in a specification including other information, dividend displacement is no longer rejected. Under these circumstances dividends exhibit weak incremental predictive power for earnings and earnings expectations and hence have little impact on value. We show that valuation models are sensitive to model specification and should be used with caution when testing the value impact of firm characteristics or accounting numbers.

Corporate Social Performance, Competitive Advantage, Earnings Persistence and Firm Value

“…Barth and Clinch () examine various deflators, before concluding that deflating by number of shares is the least problematic deflator on simulated US data. Rees () also uses the number of shares as a deflator, whilst Rees and Valentincic () employ book value. While opening book value, closing book value, opening market value and sales are possible choices for the deflator, here we limit ourselves to the number of shares and closing book value as our two deflators of choice.…”

Valuation and Forecasting Roles of Dividends of Indonesian Listed Firms

“…This is counter to theoretical reasons that predict that dividends should reduce value on a one‐to‐one basis (dividend displacement). In a recent paper, Rees and Valentincic () show that this positive relation is driven by the relationship between the following: (i) dividends and core earnings, and (ii) dividends and other information (OI) derived from the valuation error in the prior year. If core earnings can be effectively modeled in a valuation specification including OI, Rees and Valentincic () show that dividend displacement can no longer be rejected.…”

“…In a recent paper, Rees and Valentincic () show that this positive relation is driven by the relationship between the following: (i) dividends and core earnings, and (ii) dividends and other information (OI) derived from the valuation error in the prior year. If core earnings can be effectively modeled in a valuation specification including OI, Rees and Valentincic () show that dividend displacement can no longer be rejected. They achieve this by modeling expectations about future profitability, either explicitly or implicitly by excluding loss‐making observations that do not pay dividends.…”

“…However, other studies show that the Indonesian market is not yet efficient (e.g., Jarret, ). Other than being important in pricing of shares, dividends may act as predictors of future core earnings in the absence of OI (Rees and Valentincic, ). Leuz et al.…”

“…In relation to value relevance of accounting information, recent models proposed by scholars (e.g., Rees and Valentincic, ) indicate a way to minimize the negative impact on market valuation of shares caused by low quality of accounting information (in this case earnings). Therefore, examining the dividends’ role in the firms’ valuation is important for the Indonesian environment as well as for other international contexts where earnings quality is low.…”