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

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

Posted: 30 Oct 1996

See all articles by Stephen H. Penman

Stephen H. Penman

Columbia University - Columbia Business School, Accounting, Business Law & Taxation; Bocconi University

Theodore Sougiannis

University of Illinois at Urbana-Champaign - Department of Accountancy

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 Classification: G12, G35, M41, M44

Suggested Citation

Penman, Stephen H. and Sougiannis, Theodore, The Dividend Displacement Property and the Substitution of Anticipated Earnings for Dividends in Equity Valuation. THE ACCOUNTING REVIEW, Vol 72, No 1, January 1997, Available at SSRN: https://ssrn.com/abstract=2785

Stephen H. Penman (Contact Author)

Columbia University - Columbia Business School, Accounting, Business Law & Taxation ( email )

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Theodore Sougiannis

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

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