Value Relevance of Book Value, Retained Earnings and Dividends: Premium vs. Discount Firms

Abstract:     
This paper argues that from the perspective of both the residual income and option-style valuation models, the relative valuation roles of earnings, book value and dividends should differ fundamentally between firms that trade at a premium vis-à-vis discount to book value. We hypothesise and find that earnings (book value) have a more important role in equity valuation when firms trade at a premium (discount) to book value. We also find that if one controls for the premium/discount condition of the firm, other known influential conditions, such as the sign of earnings (Collins et al. 1999) and relative levels of earnings and book value (Burgstahler and Dichev 1997), become inconsequential. The discovered relationships between the discount/premium characteristic of the firm and the relative valuation roles of book value, earnings and dividends are robust to the effect of time, informational environment and the industry of the firm.

Number of Pages in PDF File: 38

Keywords: value relevance, information content, earnings, market-to-book, book value, dividends

JEL Classification: M41, G12, G14, C21

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