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An International Meeting of American Accounting
Association
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The Non-equivalence of the Earnings and Dividends Approaches to Equity Valuation |
Jack Douglas Stecher
Norwegian School of Economics and Business Administration
Abstract: Accounting theory treats a wide class of equity valuation approaches as equivalent. For example, under clean surplus accounting, the earnings approach is viewed as equivalent to the discounted dividends approach. Empirical research, however, typically finds that the two approaches do not predict market prices equally well.
This paper offers a theoretical explanation for this apparent anomaly: expectations of discounted infinite sums (incomes, cash flows, or dividends) are undefined unless some restrictive probabilistic conditions hold. Without the usual stationarity and ergodicity assumptions, it may still be possible to estimate upper and lower bounds on such sums, but these bounds need not coincide. In such a setting, earnings and discounted dividends yield intervals of justifiable valuations, which intersect but may differ.