Residual income, non‐earnings information, and information content

Abstract

We extend Ohlson's (1995) model and examine the relationship between returns and residual income that incorporate analysts' earnings forecasts and other non-earnings information variables in the balance sheet, namely default probability and agency cost of a debt covenant contract. We further divide the sample based on bankruptcy (agency) costs, earnings components and growth opportunities of a firm to explore how these factors affect the returns-residual income link. We find that the relative predictive ability for contemporaneous stock price by considering other earnings and non-earnings information is better than that of models without non-earnings information. If the bankruptcy (agency) cost of a firm is higher, its information role in the firm's equity valuation becomes more important and the accuracy of price prediction is therefore higher. As for non-earnings information, if bankruptcy (agency) cost is lower, the information role becomes more relevant, and the earnings response coefficient is hence higher. Moreover, the decomposition of unexpected residual income into permanent and transitory components induces more information than that of the unexpected residual income alone. The permanent component has a larger impact than the transitory component in explaining abnormal returns. The market and industry properties and growth opportunity also have incremental explanatory power in valuation. Copyright © 2008 John Wiley & Sons, Ltd.

Estimating private information usage amongst analysts: evidence from UK earnings forecasts

“…6 6 It is possible to allow other exogenous variables into this LIM; see, for example, Tsay et al (2009), within the context of Ohlson's (1995) residual income valuation model . Furthermore, Lee and Swaminathan (1999) and Lee et al (1999) demonstrate that a residual income valuation model that incorporates time‐varying interest rates and analyst forecast errors has superior predictive power for future returns.…”

A state space framework for the residual income valuation model of stock prices

“…Since DHS, however, recent empirical works have incorporated residual income information dynamics in addition to other value-relevant information, and empirically do a better job than competing variants of the dividend discount model. For instance, Tsay et al (2008Tsay et al ( , 2009 incorporate non-earnings information variables (e.g. bankruptcy costs, earnings components, and growth opportunities) in addition to consensus analysts' earnings forecasts.…”