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Book Value, Residual Earnings, and Equilibrium Firm Value with Asymmetric Information

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  • Young K. Kwon

    (University of Illinois at Urbana-Champaign)

Abstract

The residual income valuation model (RIM) by Ohlson (1995) and Feltham and Ohlson (1995) assumes that investors are risk-neutral with homogenous beliefs. Thus, the present value of expected dividends represents firm value. The purpose of the present study is to derive a RIM in a market setting of the Kyle (1985) type. Since traders are asymmetrically informed in the Kyle setting, firm value is no longer equivalent to the present value of the firm's expected dividends. In the present model, the informed investor observes a signal about the firm's profitability, which the market maker (who sets the price) is unable to observe. The market maker infers the informed investor's private signal based on the total order flow, which is an informative but noisy signal. The analysis identifies the equilibrium firm value as a linear function of current book value, current residual income, and the aggregate order flow.

Suggested Citation

  • Young K. Kwon, 2001. "Book Value, Residual Earnings, and Equilibrium Firm Value with Asymmetric Information," Review of Accounting Studies, Springer, vol. 6(4), pages 387-395, December.
    • Handle: RePEc:spr:reaccs:v:6:y:2001:i:4:d:10.1023_a:1012445830268
    DOI: 10.1023/A:1012445830268
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