Opportunities Knocking: Residual Income Valuation of an Adaptive Firm

60 Pages Posted: 30 Aug 2000

Abstract

Maintaining a competitive edge requires a firm to replace deteriorating business lines with new projects. Accordingly, part of a firm's value resides in its ability to exploit new opportunities. This article incorporates adaptation into Ohlson's residual income valuation framework and obtains a non-linear (convex) valuation formula. Although parsimoniously cast, the model makes two predictions which are consistent with phenomena reported in the empirical literature: earnings convexity and complementarity. Moreover, the Appendix introduces a new and powerful Equivalence Theorem. This Equivalence Theorem relates Modigliani-Miller dividend invariance to complementarity and earnings convexity in accounting-based valuation.

Keywords: Residual Income Valuation, Modigliani Miller invariance, Non-Linearity, Adaptation

JEL Classification: D81, D46, M41, D92, D84, G12

Suggested Citation

Yee, Kenton K., Opportunities Knocking: Residual Income Valuation of an Adaptive Firm. Journal of Accounting, Auditing and Finance, Vol. 15, No. 3, pp. 225-266, Summer 2000, Available at SSRN: https://ssrn.com/abstract=239368 or http://dx.doi.org/10.2139/ssrn.239368

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