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Real (adaptation) options and the valuation of equity: some empirical evidence
Author(s) -
Ataullah Ali,
Higson Andrew,
Tippett Mark
Publication year - 2006
Publication title -
abacus
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.632
H-Index - 45
eISSN - 1467-6281
pISSN - 0001-3072
DOI - 10.1111/j.1467-6281.2006.00199.x
Subject(s) - equity (law) , valuation (finance) , equity ratio , equity capital markets , equity value , business , book value , equity risk , sample (material) , residual income valuation , economics , financial economics , dividend , accounting , econometrics , finance , earnings , debt , chemistry , chromatography , debt levels and flows , external debt , political science , law
Data from 1,374 firms across four broad industrial groupings are used to assess the contribution that real (adaptation) options make to overall equity values. The analysis indicates that real (adaptation) options make a significant contribution to the equity value of firms with a market to book ratio (of equity) of around unity or less. As the market to book ratio grows beyond this level, however, the contribution made by real (adaptation) options decays quickly away and equity values are mainly comprised of the present value of the dividends that firms are expected to pay. This means that for around one in every five of the firms in our sample real (adaptation) options make a significant contribution to overall equity value. Thus, while linear equity valuation models would seem to be appropriate for the substantial majority of firms on which our sample is based, there is a sizeable minority of firms where real (adaptation) options have a significant impact on equity values. For this latter group of firms there will be a non‐linear relationship between equity value and its determining variables. This has important implications for the regression procedures that are applied in this area of accounting research.