Assuming the clean surplus relation, the Edwards-Bell-Ohlson residual income valuation (RIV) model expresses market value of equity as the sum of the book value of equity and the expected discounted future residual incomes. Without assuming the clean surplus relation, Ohlson and Juettner-Nauroth (2000) articulate the role of forward earnings per share in valuation. We compare the implied costs of equity capital from these two approaches to earnings-based valuation within seven developed countries. We hypothesise superior performance from the RIV model in countries where the clean surplus relation holds well. First, we provide preliminary international evidence on the frequency and magnitude of the clean surplus deviations. Consistent with our hypothesis, we document superior reliability of the implied cost of equity capital derived from the RIV model when clean surplus adequately describes the firms' financial reporting. That is, the implied cost of equity capital derived from Ohlson and Juettner-Nauroth (2000) is relatively more reliable in countries where the clean surplus deviations are common. Our analyses suggest that the proper choice of earnings-based valuation model may depend on analysts' interpretation of their financial reporting environment.
|Journal||Accounting and Business Research|
|Number of pages||22|
|Publication status||Published - 2004|