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Dividend Policy Irrelevancy and the Construct of Earnings
Author(s) -
Gao Zhan,
Ohlson James A.,
Ostaszewski Adam J.
Publication year - 2013
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/jbfa.12019
Subject(s) - earnings , dividend , valuation (finance) , economics , equity (law) , econometrics , cash flow , dividend policy , financial economics , accounting , finance , political science , law
Abstract This paper analyzes the characteristics of earnings in valuation settings where the dividend policy is irrelevant to equity value. The paper first demonstrates an equivalent characterization of dividend policy irrelevancy (DPI) in a general linear dynamic. It then proceeds to show how DPI leads to ideal and practical constructs of earnings and examines their analytical properties. We further demonstrate that earnings properties can be used to deduce the core approach in practical equity valuation – namely, measures of growth in expected earnings explain the price to forward earnings ratio. However, unlike dividends, free cash flow cannot generally be claimed to be irrelevant to value.