Interpretability of Empirical Valuation Models in the Value Relevance Literature

Abstract

This paper proposes an alternative formulation of the information dynamics that can serve as a foundation for the linear valuation models tested in empirical research. The models tested in the literature express market value either as a function of earnings and equity book value (net income form) or residual income and equity book value (residual income form). The net income form deviates from its theoretical development by excluding either current dividends or prior equity book value. The current formulation is consistent with the valuation models tested in the literature, and without the need to include a discount rate. The current study provide expectations on the regression coefficients produced from the empiricist's tests. Finally, since model selection is fundamentally an empirical question, we propose a model specification test for choosing among modeling alternatives.