IDEAS home Printed from https://ideas.repec.org/a/spr/reaccs/v15y2010i2d10.1007_s11142-010-9119-2.html
   My bibliography  Save this article

Return predictability and shareholders’ real options

Author

Listed:
  • Lee-Seok Hwang

    (Seoul National University)

  • Byungcherl Charlie Sohn

    (City University of Hong Kong (CityUHK))

Abstract

This study re-interprets the properties of the residual income model by highlighting the shareholders’ abandonment (liquidation or adaptation) option. We estimate the value of this real option as an explicit component of abnormal earnings in the residual income model and test the improvement in valuation after incorporating it into the model. Relative to the traditional specification of the residual income model, this real options model has a stronger predictive power for future abnormal stock returns. We also find that the superior return predictability of the real options model is pronounced in the set of firms with a high probability of exercising liquidation options (for example, those with low profitability, low growth opportunities, high underlying asset volatility, and low intangible assets), which is consistent with the importance of shareholders’ abandonment option in equity valuation. The results are robust to extensive sensitivity checks.

Suggested Citation

  • Lee-Seok Hwang & Byungcherl Charlie Sohn, 2010. "Return predictability and shareholders’ real options," Review of Accounting Studies, Springer, vol. 15(2), pages 367-402, June.
    • Handle: RePEc:spr:reaccs:v:15:y:2010:i:2:d:10.1007_s11142-010-9119-2
    DOI: 10.1007/s11142-010-9119-2
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1007/s11142-010-9119-2
    File Function: Abstract
    Download Restriction: Access to the full text of the articles in this series is restricted.
    File URL: https://libkey.io/10.1007/s11142-010-9119-2?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to

    for a different version of it.

    References listed on IDEAS

    as
    1. Johnson, Shane A. & Tian, Yisong S., 2000. "Indexed executive stock options," Journal of Financial Economics, Elsevier, vol. 57(1), pages 35-64, July.
    2. Stephen H. Penman, 2006. "Handling Valuation Models," Journal of Applied Corporate Finance, Morgan Stanley, vol. 18(2), pages 48-55, March.
    3. Chen, Peter & Zhang, Guochang, 2007. "How do accounting variables explain stock price movements? Theory and evidence," Journal of Accounting and Economics, Elsevier, vol. 43(2-3), pages 219-244, July.
    4. James Claus & Jacob Thomas, 2001. "Equity Premia as Low as Three Percent? Evidence from Analysts' Earnings Forecasts for Domestic and International Stock Markets," Journal of Finance, American Finance Association, vol. 56(5), pages 1629-1666, October.
    5. Zhang, GC, 2000. "Accounting information, capital investment decisions, and equity valuation: Theory and empirical implications," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 38(2), pages 271-295.
    6. William R. Gebhardt & Charles M. C. Lee & Bhaskaran Swaminathan, 2001. "Toward an Implied Cost of Capital," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 39(1), pages 135-176, June.
    7. Dechow, Patricia M. & Hutton, Amy P. & Sloan, Richard G., 1999. "An empirical assessment of the residual income valuation model1," Journal of Accounting and Economics, Elsevier, vol. 26(1-3), pages 1-34, January.
    8. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    9. Gary C. Biddle & Peter Chen & Guochang Zhang, 2001. "When Capital Follows Profitability: Non-linear Residual Income Dynamics," Review of Accounting Studies, Springer, vol. 6(2), pages 229-265, June.
    10. Charles M. C. Lee & James Myers & Bhaskaran Swaminathan, 1999. "What is the Intrinsic Value of the Dow?," Journal of Finance, American Finance Association, vol. 54(5), pages 1693-1741, October.
    11. Joseph R. Gordon & Myron J. Gordon, 1997. "The Finite Horizon Expected Return Model," Financial Analysts Journal, Taylor & Francis Journals, vol. 53(3), pages 52-61, May.
    12. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    13. Frankel, Richard & Lee, Charles M. C., 1998. "Accounting valuation, market expectation, and cross-sectional stock returns," Journal of Accounting and Economics, Elsevier, vol. 25(3), pages 283-319, June.
    14. James A. Ohlson & Beate E. Juettner-Nauroth, 2005. "Expected EPS and EPS Growth as Determinantsof Value," Review of Accounting Studies, Springer, vol. 10(2), pages 349-365, September.
    15. Vuong, Quang H, 1989. "Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses," Econometrica, Econometric Society, vol. 57(2), pages 307-333, March.
    16. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
    17. Dechow, Patricia M., 1994. "Accounting earnings and cash flows as measures of firm performance : The role of accounting accruals," Journal of Accounting and Economics, Elsevier, vol. 18(1), pages 3-42, July.
    18. Collins, Daniel W. & Maydew, Edward L. & Weiss, Ira S., 1997. "Changes in the value-relevance of earnings and book values over the past forty years," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 39-67, December.
    19. Abarbanell, J & Bernard, V, 2000. "Is the US stock market myopic?," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 38(2), pages 221-242.
    20. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    21. Dan Gode & Partha Mohanram, 2003. "Inferring the Cost of Capital Using the Ohlson–Juettner Model," Review of Accounting Studies, Springer, vol. 8(4), pages 399-431, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Kothari, S. P., 2001. "Capital markets research in accounting," Journal of Accounting and Economics, Elsevier, vol. 31(1-3), pages 105-231, September.
    2. Christian Bach, 2011. "Conservatism in Corporate Valuation," CREATES Research Papers 2011-32, Department of Economics and Business Economics, Aarhus University.
    3. Lee-Seok Hwang & Woo-Jong Lee, 2013. "Stock Return Predictability of Residual-Income-Based Valuation: Risk or Mispricing?," Abacus, Accounting Foundation, University of Sydney, vol. 49(2), pages 219-241, June.
    4. Tristan Fitzgerald & Stephen Gray & Jason Hall & Ravi Jeyaraj, 2013. "Unconstrained estimates of the equity risk premium," Review of Accounting Studies, Springer, vol. 18(2), pages 560-639, June.
    5. Cong, Lin William & George, Nathan Darden & Wang, Guojun, 2023. "RIM-based value premium and factor pricing using value-price divergence," Journal of Banking & Finance, Elsevier, vol. 149(C).
    6. Erica X. N. Li & Dmitry Livdan & Lu Zhang, 2009. "Anomalies," The Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4301-4334, November.
    7. Mark T. Bradshaw & Michael S. Drake & James N. Myers & Linda A. Myers, 2012. "A re-examination of analysts’ superiority over time-series forecasts of annual earnings," Review of Accounting Studies, Springer, vol. 17(4), pages 944-968, December.
    8. Partha Mohanram & Dan Gode, 2013. "Removing predictable analyst forecast errors to improve implied cost of equity estimates," Review of Accounting Studies, Springer, vol. 18(2), pages 443-478, June.
    9. Barth, Mary E. & Konchitchki, Yaniv & Landsman, Wayne R., 2013. "Cost of capital and earnings transparency," Journal of Accounting and Economics, Elsevier, vol. 55(2), pages 206-224.
    10. Zhihong Chen & Dan S. Dhaliwal & Hong Xie, 2010. "Regulation fair disclosure and the cost of equity capital," Review of Accounting Studies, Springer, vol. 15(1), pages 106-144, March.
    11. Ding, Xiaoya (Sara) & Ni, Yang & Rahman, Abdul & Saadi, Samir, 2015. "Housing price growth and the cost of equity capital," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 283-300.
    12. Kevin K. Li & Partha Mohanram, 2014. "Evaluating cross-sectional forecasting models for implied cost of capital," Review of Accounting Studies, Springer, vol. 19(3), pages 1152-1185, September.
    13. Gordon Richardson & Surjit Tinaikar, 2004. "Accounting based valuation models: what have we learned?," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 44(2), pages 223-255, July.
    14. David Ashton & Pengguo Wang, 2013. "Terminal valuations, growth rates and the implied cost of capital," Review of Accounting Studies, Springer, vol. 18(1), pages 261-290, March.
    15. Ran Barniv & Mark Myring, 2006. "An International Analysis of Historical and Forecast Earnings in Accounting‐Based Valuation Models," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(7‐8), pages 1087-1109, September.
    16. Stephannie Larocque, 2013. "Analysts’ earnings forecast errors and cost of equity capital estimates," Review of Accounting Studies, Springer, vol. 18(1), pages 135-166, March.
    17. Stephanie A. Sikes & Robert E. Verrecchia, 2015. "Dividend tax capitalization and liquidity," Review of Accounting Studies, Springer, vol. 20(4), pages 1334-1372, December.
    18. Rjiba, Hatem & Saadi, Samir & Boubaker, Sabri & Ding, Xiaoya (Sara), 2021. "Annual report readability and the cost of equity capital," Journal of Corporate Finance, Elsevier, vol. 67(C).
    19. Hail, Luzi & Leuz, Christian, 2009. "Cost of capital effects and changes in growth expectations around U.S. cross-listings," Journal of Financial Economics, Elsevier, vol. 93(3), pages 428-454, September.
    20. Christian Bach & Peter O. Christensen, 2016. "Consumption-based equity valuation," Review of Accounting Studies, Springer, vol. 21(4), pages 1149-1202, December.

    More about this item

    Keywords

    ;
    ;
    ;
    ;
    ;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:reaccs:v:15:y:2010:i:2:d:10.1007_s11142-010-9119-2. See general information about how to correct material in RePEc.

    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 CitEc recognized a bibliographic reference but did not link an item in RePEc 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

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

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.