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Equity Valuation Employing the Ideal versus Ad Hoc Terminal Value Expressions



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Equity Valuation Employing the Ideal versus Ad Hoc Terminal Value Expressions LUCIE COURTEAU Universit Laval JENNIFER L KAO University of Alberta GORDON D RICHARDSON University of Waterloo Abstract Recently Penman and Sougiannis 1998 and Francis Olsson and Oswald 2000 compared the bias and accuracy of the discounted cash flow model DCF and Edwards Bell Ohlson residual income model RIM in explaining the relation between value estimates and observed stock prices Both studies report that with non price based terminal values RIM outperforms DCF Our first research objective is to explore the question whether over a five year valuation horizon DCF and RIM are empirically equivalent when Penman s 1997 theoretically ideal terminal value expressions are employed in each model Using Value Line terminal stock price forecasts at the horizon to proxy for such values we find empirical support for the prediction of equivalence between these valuation models Thus the apparent superiority of RIM does not hold in a level playing field comparison Our second research objective is to demonstrate that within each class of the DCF and RIM valuation models the model that employs Value Line forecasted price in the terminal value expression generates the lowest prediction errors compared with models that employ non price based terminal values under arbitrary growth assumptions The results indicate Accepted by Jerry Feltham This paper was presented at the 2000 Contemporary Accounting Research Conference generously supported by the CGA Canada Research Foundation the Canadian Institute of Chartered Accountants the Society of Management Accountants of Canada the Certified General Accountants of British Columbia the Certified Management Accountants Society of British Columbia and the Institute of Chartered Accountants of British Columbia We would like to thank workshop participants at the 2000 American Accounting Association meetings 2000 Canadian Academic Accounting Association Conference 2000 Contemporary Accounting Research Conference 2000 European Accounting Association Conference HEC Laval University of Queensland University of Technology Sydney and University of Waterloo for their comments Special thanks are extended to Sati Bandyopadhyay Joy Begley Brian Bushee Peter Clarkson Steve Fortin Kin Lo Russell Lundholm the discussant Pat O Brien Terry O Keefe Steve Penman Ranjini Sivakumar Theodore Sougiannis Ken Vetzal and especially Jerry Feltham the editor for their helpful comments and suggestions on earlier versions of the paper Kendrick Fiorito and Mort Siegel at Value Line for their advice on the project Nick Favron for programming assistance and Daniel Roy and Nicole Sirois for their excellent research assistance The research is supported by the Social Sciences and Humanities Research Council of Canada and the Canadian Academic Accounting Association Jennifer Kao also receives financial support from Canadian Utilities Fellowship for this project All remaining errors are the authors sole responsibility Contemporary Accounting Research Vol 18 No 4 Winter 2001 pp 625 61 CAAA 626 Contemporary Accounting Research that for both DCF and RIM price based valuation models outperform the corresponding non price based models by a wide margin These results imply that researchers should exercise care in interpreting findings from models using ad hoc terminal value expressions Keywords Financial information Residual income model Terminal values Valuation Condens Penman et Sougiannis 1998 ci apr s P S comparaient r cemment la distorsion et la pr cision du mod le d actualisation des flux de tr sorerie DCF et du mod le des b n fices r siduels d Edwards Bell et Ohlson RIM dans l explication de la relation entre les estimations de valeur et le cours observ des actions Utilisant les b n fices futurs r els comme mesure des b n fices attendus P S 1998 constatent que les erreurs d valuation du mod le DCF sur un horizon de 10 ans exc dent largement celles du mod le RIM Ils attribuent ce r sultat au fait que des montants comptabilis s conform ment aux PCGR dans le mod le RIM permettent une prise en compte plus rapide de flux de tr sorerie futurs de sorte que leur pertinence l gard de la valeur est plus grande que celle des flux de tr sorerie ou des dividendes Francis Olsson et Oswald 2000 jettent un nouveau regard sur ce parall le en recourant une m thode ex ante et aux pr visions de Value Line VL pour conclure leur tour que lorsque les valeurs finales ne sont pas fond es sur les pr visions du cours des actions l efficacit du RIM est sup rieure celle du DCF Le premier objectif des auteurs est de v rifier si sur un horizon pr visionnel de cinq ans le DCF et le RIM sont empiriquement quivalents lorsqu on utilise les expressions de valeur finale th oriquement id ales de Penman 1997 dans l application de chacun des mod les Ces expressions de valeur n cessitent le cours du march pr vu P au terme de l horizon pr visionnel et l exc dent de ce cours sur la valeur comptable pour un syst me comptable donn L quivalence des mod les DCF et RIM pour des horizons finis et dans des conditions id ales malgr qu elle soit bien tablie en th orie n a pas t d montr e dans les tudes empiriques Au premier abord les arguments semblent circulaires si des pr visions fiables de cours sont disponibles le mod le d actualisation des dividendes DDM devrait suffire et il n est pas n cessaire de recourir au DCF ou au RIM La chose n est cependant pas vidente du fait que les pr visions de cours formul es par le march ne sont pas observables les auteurs utilisent donc les pr visions de cours final de VL comme substitut Bien que ces pr visions soient loin d tre id ales et qu elles puissent contenir des erreurs de distorsion ou de mesure voir Abarbanell et Bernard 2000 les auteurs font l hypoth se que toute erreur de distorsion ou de mesure serait un facteur constant dans les comparaisons entre DCF et RIM Ils supposent galement comme P S 1998 et Francis et al 2000 que le march est efficient Le deuxi me objectif des auteurs consiste d montrer que les valeurs intrins ques calcul es l aide des pr visions de cours final de VL donnent lieu des erreurs d valuation plus modestes que les valeurs intrins ques d termin es en fonction des expressions de valeur finale improvis es Les expressions simples de perp tuit qui supposent que les b n fices anormaux post rieurs l horizon pr visionnel cro tront soit au taux de 0 pour cent soit au taux nominal d inflation ont t amplement


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