Advanced Search
MyIDEAS: Login

Splitting up value: A critical review of residual income theories

Contents:

Author Info

  • Magni, Carlo Alberto

Abstract

This paper deals with the notion of residual income, which may be defined as the surplus profit that residues after a capital charge (opportunity cost) has been covered. While the origins of the notion trace back to the 19th century, in-depth theoretical investigations and widespread real-life applications are relatively recent and concern an interdisciplinary field connecting management accounting, corporate finance and financial mathematics (Peasnell, 1981, 1982; Peccati, 1987, 1989, 1991; Stewart, 1991; Ohlson, 1995; Arnold and Davies, 2000; Young and O'Byrne, 2001; Martin, Petty and Rich, 2003). This paper presents both a historical outline of its birth and development and an overview of the main recent contributions regarding capital budgeting decisions, production and sales decisions, implementation of optimal portfolios, forecasts of asset prices and calculation of intrinsic values. A most recent theory, the systemic-value-added approach (also named lost-capital paradigm), provides a different definition of residual income, consistent with arbitrage theory. Enfolded in Keynes's (1936) notion of user cost and forerun by Pressacco and Stucchi (1997), the theory has been formally introduced in Magni (2000a,b,c; 2001a,b; 2003), where its properties are thoroughly investigated as well as its relations with the standard theory; two different lost-capital metrics have been considered, for value-based management purposes, by Drukarczyk and Schueler (2000) and Young and O'Byrne (2001). This work illustrates the main properties of the two theories and their relations, and provides a minimal guide to construction of performance metrics in the two approaches.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sciencedirect.com/science/article/B6VCT-4THSX3J-1/2/6cc60f189439149bd4f3268147543922
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Elsevier in its journal European Journal of Operational Research.

Volume (Year): 198 (2009)
Issue (Month): 1 (October)
Pages: 1-22

as in new window
Handle: RePEc:eee:ejores:v:198:y:2009:i:1:p:1-22

Contact details of provider:
Web page: http://www.elsevier.com/locate/eor

Related research

Keywords: Finance Economics Accounting Investment analysis Residual income Excess profit Net present value Opportunity cost Counterfactual Performance measurement Management;

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Cigola, Margherita & Peccati, Lorenzo, 2005. "On the comparison between the APV and the NPV computed via the WACC," European Journal of Operational Research, Elsevier, vol. 161(2), pages 377-385, March.
  2. Magni, Carlo Alberto, 2007. "CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation," MPRA Paper 5468, University Library of Munich, Germany.
  3. repec:pra:mprapa:5719 is not listed on IDEAS
  4. Ignacio Vélez Pareja & Joseph Tham, 2004. "EVA(c) Made Simple: Is it Possible?," MEDICION EVALUACION DEL VALOR 001895, POLITÉCNICO GRANCOLOMBIANO.
  5. Magni, Carlo Alberto, 2005. "On decomposing net final values: EVA, SVA, and shadow project," MPRA Paper 12357, University Library of Munich, Germany.
  6. Magni, Carlo Alberto, 2007. "Correct or incorrect application of CAPM? Correct or incorrect decisions with CAPM?," MPRA Paper 5471, University Library of Munich, Germany.
  7. Magni, Carlo Alberto, 2007. "Residual income and value creation: An investigation into the lost-capital paradigm," MPRA Paper 7335, University Library of Munich, Germany.
  8. Richard P. Brief, 2007. "Accounting Valuation Models: A Short Primer," Abacus, Accounting Foundation, University of Sydney, vol. 43(4), pages 429-437.
  9. repec:pra:mprapa:6309 is not listed on IDEAS
  10. Rick Antle & Gary D. Eppen, 1985. "Capital Rationing and Organizational Slack in Capital Budgeting," Management Science, INFORMS, vol. 31(2), pages 163-174, February.
  11. Carlo Alberto Magni, 2003. "Decomposition of Net Final Values: Systemic Value Added and Residual Income," Bulletin of Economic Research, Wiley Blackwell, vol. 55(2), pages 149-176, 04.
  12. Carlo Alberto Magni, 2007. "A Sum&Discount Method for Appraising Firms: An Illustrative Example," Department of Economics 0572, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
  13. Carlo Magni, 2005. "On Decomposing Net Final Values: Eva, Sva and Shadow Project," Theory and Decision, Springer, vol. 59(1), pages 51-95, 08.
  14. Thomas Pfeiffer, 2004. "Net Present Value-Consistent Investment Criteria Based on Accruals: A Generalisation of the Residual Income-Identity," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(7-8), pages 905-926.
  15. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
  16. Sunil Dutta, 2002. "Revenue Recognition in a Multiperiod Agency Setting," Journal of Accounting Research, Wiley Blackwell, vol. 40(1), pages 67-83, 03.
  17. Weingartner, H. Martin, 1966. "The Generalized Rate of Return," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 1(03), pages 1-29, September.
  18. Magni, Carlo Alberto, 2000. "Irr, Roe and Npv: Formal and Conceptual Convergences in a Systemic Approach," MPRA Paper 7600, University Library of Munich, Germany.
  19. Boadway, Robin & Bruce, Neil, 1984. "A general proposition on the design of a neutral business tax," Journal of Public Economics, Elsevier, vol. 24(2), pages 231-239, July.
  20. Weaver, Samuel C. & Weston, J. Fred, 2003. "A Unifying Theory of Value Based Management," University of California at Los Angeles, Anderson Graduate School of Management qt0xw5m9mz, Anderson Graduate School of Management, UCLA.
  21. Ignacio Velez-Pareja, 2001. "Economic Value Measurement: Investment Recovery and Value Added - IRVA," MEDICION EVALUACION DEL VALOR 002404, POLITÉCNICO GRANCOLOMBIANO.
  22. Daniel Teichroew & Alexander A. Robichek & Michael Montalbano, 1965. "Mathematical Analysis of Rates of Return Under Certainty," Management Science, INFORMS, vol. 11(3), pages 395-403, January.
  23. Magni, Carlo Alberto, 2004. "Modelling excess profit," Economic Modelling, Elsevier, vol. 21(3), pages 595-617, May.
  24. Rogerson, William P, 1997. "Intertemporal Cost Allocation and Managerial Investment Incentives: A Theory Explaining the Use of Economic Value Added as a Performance Measure," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 770-95, August.
  25. Gallo, Paolo & Peccati, Lorenzo, 1993. "The appraisal of industrial investments: A new method and a case study," International Journal of Production Economics, Elsevier, vol. 30(1), pages 465-476, July.
  26. Stoughton, Neal M. & Zechner, Josef, 2007. "Optimal capital allocation using RAROC(TM) and EVA(R)," Journal of Financial Intermediation, Elsevier, vol. 16(3), pages 312-342, July.
  27. Magni, Carlo Alberto, 2000. "Decomposition of a Certain Cash Flow Stream: Differential Systemic Value and Net Final Value," MPRA Paper 7308, University Library of Munich, Germany.
  28. Fernández , Pablo, 2002. "Valuing companies by cash flow discounting: Ten methods and nine theories," IESE Research Papers D/451, IESE Business School.
  29. Joseph Tham & Ignacio Velez-Pareja, 2000. "The Correct Discount Rate for the Tax Shield: The N-period Case," MEDICION EVALUACION DEL VALOR 003578, POLITÉCNICO GRANCOLOMBIANO.
  30. Carlo Alberto Magni, 2009. "Opportunity Cost, Excess Profit, and Counterfactual Conditionals," Frontiers in Finance and Economics, SKEMA Business School, vol. 6(1), pages 118-154, April.
  31. Stephen F. O'Byrne & S. David Young, 2006. "Incentives and Investor Expectations," Journal of Applied Corporate Finance, Morgan Stanley, vol. 18(2), pages 98-105.
  32. repec:pra:mprapa:6359 is not listed on IDEAS
  33. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411.
  34. Thomas Pfeiffer & Georg Schneider, 2007. "Residual Income-Based Compensation Plans for Controlling Investment Decisions Under Sequential Private Information," Management Science, INFORMS, vol. 53(3), pages 495-507, March.
  35. Fernandez, Pablo, 2005. "Reply to "Comment on the value of tax shields is NOT equal to the present value of tax shields"," IESE Research Papers D/579, IESE Business School.
  36. magni, Carlo Alberto, 2006. "Zelig and the Art of Measuring Excess Profit," MPRA Paper 5663, University Library of Munich, Germany.
  37. Gunther Friedl, 2005. "Incentive Properties of Residual Income When There is an Option to Wait," Schmalenbach Business Review (sbr), LMU Munich School of Management, vol. 57(1), pages 3–21, January.
  38. Magni, Carlo Alberto, 2000. "Systemic Value Added, Residual Income and Decomposition of a Cash Flow Stream," MPRA Paper 5900, University Library of Munich, Germany.
  39. Magni, Carlo Alberto, 2000. "Scomposizione di sovraprofitti: Economic Value Added e Valore Aggiunto Sistemico
    [Excess-profit decomposition: Economic Value Added and Systemic Value Added]    ," MPRA Paper 8935, University Library of Munich, Germany.
  40. Flavio Pressacco & Patrizia Stucchi, 1997. "Su Una Estensione Bidimensionale del Teorema di Scomposizione di Peccati," Decisions in Economics and Finance, Springer, vol. 20(2), pages 169-185, September.
  41. Hagemeister, Meike & Kempf, Alexander, 2007. "CAPM und erwartete Renditen: Eine Untersuchung auf Basis der Erwartung von Marktteilnehmern," CFR Working Papers 07-01, University of Cologne, Centre for Financial Research (CFR).
  42. Ignacio Velez-Pareja & Joseph Tham, 2003. "Do the RIM (Residual Income Model), EVA® and DCF (Discounted Cash Flow) Really Match?," MEDICION EVALUACION DEL VALOR 002379, POLITÉCNICO GRANCOLOMBIANO.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Ghiselli Ricci, Roberto & Magni, Carlo Alberto, 2009. "Axiomatization of residual income and generation of financial securities," MPRA Paper 14438, University Library of Munich, Germany.
  2. Schüder, Stefan, 2011. "Monetary policy trade-offs in a portfolio model with endogenous asset supply," MPRA Paper 32019, University Library of Munich, Germany.
  3. Carlo Alberto Magni, 2009. "Opportunity Cost, Excess Profit, and Counterfactual Conditionals," Frontiers in Finance and Economics, SKEMA Business School, vol. 6(1), pages 118-154, April.
  4. Magni, Carlo Alberto, 2005. "On decomposing net final values: EVA, SVA, and shadow project," MPRA Paper 12357, University Library of Munich, Germany.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:eee:ejores:v:198:y:2009:i:1:p:1-22

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wendy Shamier).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.