SSRN-The Dividend Displacement Property and the Substitution of Anticipated Earnings for Dividends in Equity Valuation by Stephen H. Penman, Theodore Sougiannis

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The Dividend Displacement Property and the Substitution of Anticipated Earnings for Dividends in Equity Valuation

STEPHEN H. PENMAN
Columbia University - Department of Accounting
THEODORE SOUGIANNIS
University of Illinois at Urbana-Champaign - Department of Accountancy

THE ACCOUNTING REVIEW, Vol 72, No 1, January 1997

Abstract:
The paper demonstrates empirically that GAAP earnings have properties to serve as a substitute for dividends in equity valuation analysis. Dividends reduce subsequent GAAP earnings, and "intrinsic" equity prices calculated by forecasting earnings are thus reduced by current dividends. This is in accordance with the Miller and Modigliani principle -- the displacement property -- which states that the payment of dividends reduces prices, dollar for dollar. Further, the paper demonstrates that if this displacement is accommodated in calculating equity prices from forecasted GAAP earnings, those prices exhibit the dividend irrelevance property, that is, calculated prices are insensitive to future dividends. The accommodation involves adding the displacement value of dividends to earnings forecasts. Forecasted GAAP earnings cannot be substituted for dividends, dollar for dollar, but the two are substitutes in the sense that the replacement value of expected dividends reduces forecasted earnings, dollar for dollar.

JEL Classifications: G12, G35, M41, M44

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Contact Information for STEPHEN H. PENMAN (Contact Author) Email address for STEPHEN H. PENMAN Columbia University - Department of Accounting 3022 Broadway New York , NY 10027 United States 212-854-9151 (Phone) 212-316-9219 (Fax)
Contact Information for THEODORE SOUGIANNIS Email address for THEODORE SOUGIANNIS University of Illinois at Urbana-Champaign - Department of Accountancy 360 Wohlers Hall 1206 South Sixth Street Champaign , IL 61820 United States 217-244-0555 (Phone) 217-244-0902 (Fax)

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