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Residual income and value creation: An investigation into the lost-capital paradigm

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Author Info
Magni, Carlo Alberto

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Abstract

This paper presents a new way of measuring residual income, originally introduced by Magni (2000a, 2000b, 2003). Contrary to the standard residual income, the capital charge is equal to the capital lost by investors. The lost capital may be viewed as (a) the foregone capital, (b) the capital implicitly infused into the business, (c) the outstanding capital of a shadow project, (d) the claimholders' credit. Relations of the lost capital with book values and market values are studied, as well as relations of the lost-capital residual income with the classical standard paradigm; many appealing properties are derived, among which a property of earnings aggregation. Different concepts and results, provided by different authors in such different fields as economic theory, management accounting and corporate finance, are considered: O'Hanlon and Peasnell's (2002) unrecovered capital and Excess Value Created; Ohlson's (2005) Abnormal Earnings Growth; O'Byrne's (1997) EVA improvement; Miller and Modigliani's (1961) investment opportunities approach to valuation; Young and O'Byrne's (2001) Adjusted EVA; Keynes's (1936) user cost; Drukarczyk and Schueler's (2000) Net Economic Income, Fernandez's (2002) Created Shareholder Value, Anthony's (1975) profit. They are all conveniently reinterpreted within the theoretical domain of the lost-capital paradigm and conjoined in a unified view. The results found make this new theoretical approach a good candidate for firm valuation, incentive compensation, capital budgeting decision-making

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 6309.

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Date of creation: 13 Nov 2007
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Handle: RePEc:pra:mprapa:6309

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Related research
Keywords: Corporate finance; management accounting; firm valuation; residual income; value creation; incentive compensation; outstanding capital; lost capital; net present value; book value; market value;

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
D40 - Microeconomics - - Market Structure and Pricing - - - General
M52 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects
G30 - Financial Economics - - Corporate Finance and Governance - - - General
M40 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - General
D46 - Microeconomics - - Market Structure and Pricing - - - Value Theory
M41 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - Accounting
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G0 - Financial Economics - - General
M21 - Business Administration and Business Economics; Marketing; Accounting - - Business Economics - - - Business Economics

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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.:
  1. 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. [Downloadable!] (restricted)
  2. Samuel Weaver & J. Weston, 2003. "A Unifying Theory of Value Based Management," University of California at Los Angeles, Anderson Graduate School of Management 1037, Anderson Graduate School of Management, UCLA. [Downloadable!]
  3. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," Journal of Business, University of Chicago Press, vol. 34, pages 411. [Downloadable!]
  4. Carlo Alberto Magni, 2003. "Decomposition of Net Final Values: Systemic Value Added and Residual Income," Bulletin of Economic Research, Blackwell Publishing, vol. 55(2), pages 149-176, 04. [Downloadable!] (restricted)
  5. DeAngelo, Harry & DeAngelo, Linda, 2006. "The irrelevance of the MM dividend irrelevance theorem," Journal of Financial Economics, Elsevier, vol. 79(2), pages 293-315, February. [Downloadable!] (restricted)
  6. Magni, Carlo Alberto, 2003. "Opportunity cost, excess profit and counterfactual conditionals," MPRA Paper 5695, University Library of Munich, Germany. [Downloadable!]
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  7. Carlo Magni, 2005. "On Decomposing Net Final Values: Eva, Sva and Shadow Project," Theory and Decision, Springer, vol. 59(1), pages 51-95, 08. [Downloadable!] (restricted)
    Other versions:
  8. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
  9. magni, Carlo Alberto, 2006. "Zelig and the Art of Measuring Excess Profit," MPRA Paper 5663, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  10. Magni, Carlo Alberto, 2000. "Systemic Value Added, Residual Income and Decomposition of a Cash Flow Stream," MPRA Paper 5900, University Library of Munich, Germany. [Downloadable!]
  11. Magni, Carlo Alberto, 2004. "Modelling excess profit," Economic Modelling, Elsevier, vol. 21(3), pages 595-617, May. [Downloadable!] (restricted)
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  12. Magni, Carlo Alberto, 2007. "Relevance or irrelevance of retention for dividend policy irrelevance," MPRA Paper 5591, University Library of Munich, Germany, revised 2009. [Downloadable!]
  13. Roberto Ghiselli Ricci & Carlo Alberto Magni, 2006. "Economic value added and systemic value added: symmetry, additive coherence and differences in performance," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 2(3), pages 151-154, May. [Downloadable!] (restricted)
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Cited by:
(explanations, 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.)

  1. Carlo Alberto, Magni, 2008. "Splitting Up Value: A Critical Review of Residual Income Theories," MPRA Paper 10506, University Library of Munich, Germany. [Downloadable!]
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