Dividend Policy Irrelevancy and the Construct of Earnings
James A. Ohlson
New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Accounting, Taxation & Business Law
Adam J. Ostaszewski
London School of Economics
January 6, 2013
Journal of Business Finance & Accounting, Forthcoming
This paper analyzes the characteristics of earnings in valuation settings where the dividend policy is irrelevant to equity value. The paper first demonstrates an equivalent characterization of dividend policy irrelevancy (DPI) in a general linear dynamic. It then proceeds to show how DPI leads to ideal and practical constructs of earnings and examines their analytical properties. We further demonstrate that earnings properties can be used to deduce the core approach in practical equity valuation — namely, measures of growth in expected earnings explain the price to forward earnings ratio. However, unlike dividends, free cash flow cannot generally be claimed to be irrelevant to value.
Keywords: equity valuation, information dynamics, dividend policy, earnings
JEL Classification: M41, G12, G14Accepted Paper Series
Date posted: June 23, 2011 ; Last revised: January 10, 2013
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